In this article, we review:
- Why the Federal Reserve is in no hurry to implement future interest rate cuts
- Three-year annualized returns for short-dated bonds and U.S. Treasury bills following recent Fed pauses
- What the current starting point of yields can provide if we see increased macro volatility in the future
With the Federal Reserve hitting the pause button — at least for now — on additional interest rate cuts, short-term bonds can serve as an attractive option for fixed income investors. The Fed opted to stand pat at its January meeting, leaving its key benchmark rate at between 4.25% and 4.50%. At a news conference after the meeting, Fed Chairman Jerome Powell said that with interest rates now “significantly less restrictive” than they were when the Fed began cutting rates, “we do not need to be in a hurry to adjust our policy stance.” The Fed will want to give itself the time and optionality to understand the impact of rapid-fire headlines related to the Trump administration’s policies.
The case for an allocation to short duration continues to be compelling given the high level of yields, even as the Fed has cut interest rates by 100 basis points (bps). Since the Fed kicked off the cutting cycle this past September, the yield to worst for the ICE BofA 0-3 Month U.S. Treasury Bill Index has fallen by 49 bps, while the yield for the ICE BofA 1-3yr U.S. Government/Corporate Index has increased by 50 bps (through January 31, 2025).
As we have illustrated in prior publications, the months and years immediately following a Fed pause have been followed by positive total returns. The exhibit below shows 3-year annualized returns following a Fed pause for short-dated bonds and U.S. Treasury bills.
3-year annualized returns following a Fed pause
Source: ICE BofA. Data as of January 31, 2025. For illustrative purposes only. Indexes do not reflect the performance of an actual investment. It is not possible to invest directly in an index, which also does not take into account trading commissions and costs. Statements concerning financial market trends are based on current market conditions which will fluctuate. All investments contain risk and may lose value.
If we see increased macro volatility that results in wider spreads and/or higher yields, the current starting point of yields should act as a cushion to buffer short-duration investments. The yield per unit of duration (breakeven) as of January 31, 2025, based on the ICE BofA 1-3 Yr U.S. Government/Corporate Index sits just north of 240 bps. Funds that include strategic allocations to securitized credit in addition to corporates and governments have the potential to generate even larger breakevens.
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About the Author
Norbert King is a senior portfolio manager responsible for the portfolio management of investment-grade credit strategies, long credit strategy, intermediate credit strategy, and multi-sector portfolios. Prior to his current role, Norbert was an investment-grade credit trader responsible for trading across all investment-grade credit and multi-sector mandates. He has been in the industry since and started with the firm and its affiliates in 2011. Norbert received his B.A. in accounting from the University of Lynchburg and an MBA with a concentration in finance from Villanova University.
Index Definitions
The federal funds rate refers to the target interest rate range at which commercial banks borrow and lend their excess reserves to each other overnight, which is set by the Federal Open Market Committee.
The ICE BofA 0-3 Month U.S. Treasury Bill Index measures the performance of a U.S. Treasury bill that matures within three months.
The ICE BofA 1-3 Year U.S. Government/Corporate Index measures the performance of investment-grade debt issued in the U.S. This includes debt from U.S. Treasury, U.S. agencies, foreign governments, supranational entities, and corporations.
Important Information
All opinions, estimates, projections, and security selections contained herein are those of the sub-adviser. It does not constitute investment advice and should not be used as a basis for any investment decision.
Mutual funds are subject to market risk, including loss of principal. Past performance is not indicative of future results.
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Fixed income securities are subject to risks including credit risk, interest rate risk, counterparty risk, prepayment risk, extension risk, valuation risk, and liquidity risk. The value of fixed income securities generally goes down when interest rates rise, and therefore the value of your investment in the fund may also go down. High-yield bonds tend to be volatile and more susceptible to adverse events, credit downgrades and negative sentiments. Changes in interest rates, the market’s perception of the issuers and the creditworthiness of the issuers may significantly affect the value of the fund.
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