As we enter May, the outlook is cloudy – not just from spring showers, but also due to concerns about the economy related to policy decisions. Consumer and investor sentiment remains low as many grapple with uncertainty surrounding economic growth and tariffs. Despite this uncertainty, the economy continues to show resilience, which we have outlined as slowing rather than stalling in previous Strategy Updates.
The Federal Reserve assessed the state of the economy at its May 7th meeting and decided to keep interest rates unchanged while closely monitoring upcoming economic data. They are in no hurry to cut based on current healthy jobs numbers and economic growth. However, they remain ready to “open their umbrella” by cutting rates if the data turns negative. When the Fed lowers interest rates, it directly impacts the economy by reducing borrowing costs, which in turn stimulates lending and spending. Since many other rates are tied to the Fed's benchmark rate, a cut typically leads banks to lower mortgage, auto loan, and credit card rates – offering relief to both businesses and consumers.
Federal Reserve officials have noted that “risks of higher unemployment and higher inflation have risen.” Markets are reflecting this shifting tone and are currently assigning a 50% probability for a rate cut in July and an 80% chance for September. Overall, investors are pricing in a 75 basis points (0.75%) of easing in 2025, which would bring the federal funds rate down from its current range of 4.25%-4.50% to 3.50%-3.75%. Investors with large money market balances should be aware of this upcoming and likely possibility. Please contact your private client advisor to learn more about solutions for your specific situation.
Bonds Provide Yield in Uncertain Times
Uncertainty about the future can leave anyone feeling uneasy – especially investors who grow anxious when markets turn negative. Bonds with their predictable coupon payment can shine in times of equity volatility and unpredictability. A security’s total return, whether it is a stock or a bond, combines price changes with income from dividends or coupons. While bond prices can fluctuate, their coupon payments remain consistent. This steady income can provide stability during market downturns, helping your portfolio stay on track. Whether you're saving for retirement or preparing for a planned expense, bonds can offer the dependable cash flow needed to support your goals – no matter the market environment.
A reduction in the Fed funds rate will likely lead to price appreciation in bonds at the front end of the yield curve. We have seen this already happen on bonds under 5 years in duration that are most directly impacted but cuts. When interest rates fall bond prices rise, which can add to the total return of a security.
Looking at the year-over-year yield curve, you'll notice a significant decline in short-term rates. The yellow line on the chart below represents the US Treasury yield curve from last year, while the green line shows the curve as of April 2025. As the below chart demonstrates, it is no longer possible to achieve a 5% yield on short-term Treasuries.
We have seen a steepening of the yield curve, meaning short-term rates have declined relative to long-term rates – an indicator often viewed as a sign of improving economic outlook. As the chart shows, long-term rates have remained relatively unchanged compared to last year. However, if the economic environment changes, we could see long-term rates begin to fall. Long-term interest rates are primarily driven by two key components: the expected average of future short-term rates and the "term premium." The term premium reflects the compensation investors require for bearing the uncertainty and risks associated with longer-term investments. This premium incorporates factors such as expectations for future economic growth, anticipated inflation, and investor sentiment regarding risk.
Portfolio Positioning
We continue to see attractive yields in the fixed income markets. With rates falling on overseas investment-grade debt, we anticipate strong demand for US bonds. For example, the yield on 10-year government bonds issued in Germany is around 2.50%, in Japan 1.30%, and in Switzerland 0.20%. The global aggregate (ex-US) index is currently yielding around 2.6%, compared to 4.6% for the US aggregate index. This “yield advantage” tends to attract global flows into US Fixed income.
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Investment-grade corporate bond fundamentals remain strong, offering appealing yields in the current market. Credit spreads for corporate bonds are expected to stay within their recent ranges, while overall yields remain above their 15-year average. We've seen several investment grade issuers offering 4-5% coupons, and we’ve been taking advantage of these opportunities to add high-quality holdings to your portfolio.
Because we specialize in individual bond selection, we’re able to be nimble in choosing holdings – not just based on credit quality, but also on bond coupon rates. The below chart highlights this approach with examples from Apple, Microsoft, and Google. As shown, several outstanding bond issues from these companies carry coupon rates as low as 1% or 2%. Unlike passive index tracking, our strategy allows us the flexibility to target bonds with higher coupon rates, which aims to maximize your annual cash flow.
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We hope this Fixed Income Update is helpful, and feel free to share it with your colleagues, family, and friends. Please let us know if you have experienced any changes in your finances or have questions about your portfolio.
If you have a friend or family member who would be interested in a no-cost portfolio review, please let us know.
Thank you again for your continued vote of confidence in our work. Wishing you a happy and healthy Spring!
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