Investors who have been playing it safe with cash and money-market funds may want to rethink their strategy, according to Saira Malik, the Chief Investment Officer at Nuveen. By examining historical data, it becomes clear that the broader $55 trillion U.S. bond market tends to outshine short-term Treasurys as Federal Reserve rate hiking cycles come to an end.
In fact, in the past four Fed hiking cycles since the 1990s, the bond market achieved an average 5.5% three-month rolling return after the last rate hike (see chart). This is in stark contrast to the meager 2.1% return on short-term Treasurys during the same period.
It is worth noting that the bond market’s outperformance diminishes after 12 months when compared to short-term positions. This can be seen by comparing the performance of the Bloomberg U.S. Aggregate Bond Index versus the Bloomberg U.S. Treasury 1-3 Year Index.
According to Malik’s Monday client note, it is evident that the broader market usually experiences a significant relief rally right after the Fed pauses and tends to outperform the following year. Therefore, it would be a mistake for investors to overallocate to cash or short-term government debt. Instead, they should consider closing their duration underweights and shift their focus towards longer-dated bonds.
There are several ways for individuals to gain exposure to Wall Street bond indexes, such as through related exchange-traded funds. Two notable options are the iShares Core U.S. Aggregate Bond ETF (AGG) and the SPDR Bloomberg 1-3 Year U.S. Treasury Bond UCITS ETF (UK:TSY3), which offer opportunities for both broad market exposure and short-term Treasury exposure, respectively.
Additional Rate Hikes May Be Necessary to Control Rising U.S. Living Costs
In his speech at the annual Jackson Hole gathering in Wyoming, Fed Chairman Jerome Powell hinted at the potential need for further rate hikes in order to curb the increasing cost of living in the United States. Despite already reaching a 22-year high, Powell emphasized the importance of keeping inflation under control and stated his commitment to maintaining rates at a restrictive level for an extended period.
Positive Signs for Inflation Front
Economist Malik sees the cooling housing inflation as a positive development regarding inflation. With the average benchmark 30-year mortgage rate climbing to 7.31%, the highest level since 2000, home buyers have begun to pull back.
Furthermore, Malik foresees a potential slowdown in U.S. economic growth as well as a “partial retracing” of the 10-year Treasury yield following its recent surge.
According to Malik, “Historically, the 10-year yield has peaked within the last few months of the final rate hike in a tightening cycle. We expect this hike will occur at either the September or November Fed meeting, and that the 10-year yield will decline through year-end.” It is worth noting that yields and debt prices move inversely to each other.
Stock Market Performance
On Monday, stock prices showed an upward trend, with the Dow Jones Industrial Average (DJIA) rising by 0.5%, the S&P 500 index climbing 0.3%, and the Nasdaq Composite Index (COMP) experiencing a 0.4% increase, according to FactSet.