Any Retirement Salvation? Puny Bond Yields in a Rate-Hiking Cycle

We have often expressed our view that retirement financial planning should rely less on traditional bonds as historically low yields could mean meager payouts to fund daily living expenses and an increased risk of outliving one’s savings.

Will the Federal Reserve’s imminent rate-hike campaign change our message? We doubt it. Based on what we currently know, the bond market is likely not going to break out of the last decade’s historically low trading range of 0.5% to 3.3%. We believe low yields are here to stay, along with the retirement income planning challenges posed by them.

The current state of market pricing has the Fed announcing about six, quarter-point increases in the Fed Funds Rate this year, based on our calculations as of February 16, 2022. If that occurs, the Fed Funds Rate would rise from 0% currently to 1.50% by New Year’s Eve.

Markets believe the Fed is behind the curve in combating inflation and will have to move aggressively to combat the rising cost of living (see our Special Report: Ripping Off the Easy-Money Band Aid). And that belief explains why the short-end of the Treasury yield curve has been soaring since October.

At the same time, the financial markets are indicating that the Fed will succeed in its inflation fight.

You can see that belief in the more modest rise for 10-year yields, and how much closer its yield is to the two-year yield (lower panel above). In Wall Street parlance, the yield curve is flattening.

But the long-term Treasury yield picture is more complicated than that, and today’s 10-year yield of 2.01% might mark something of a high-water mark.

If the economic growth data softens and inflation pressures ease at the same time the Fed is raising short-term interest rates this year, then it’s possible long-term yields would tumble as traders get a sense of where the rate-hiking cycle will end. That has happened in the past and we would expect that to happen again this time.

The question on our mind is: what will be the peak of the Fed Funds Rate in this hiking cycle? It peaked at successively lower levels over the last three cycles: 6.50% in 2000, 5.25% in 2006 and 2.50% in 2018. Another lower peak now would suggest to us that bond yields will also max out at a lower level than in the past, leaving yields mired at multi-decade lows.

The more things have changed in terms of how the market is thinking about the Fed and rate hikes, the more we think that things have stayed the same in regards to bonds and retirement income: someone’s goal of a dignified and well-funded retirement will likely require investment ideas other than overweighting bonds. Please see our Spend strategies for how a total return approach to retirement income can help address longevity and short-fall risks.

Further reading:

Q4 Focus Magazine: The Good, The Bad and The Ugly of Inflation

2022 Outlook: The Next Unprecedented Year

Disappearing Foreclosures Add to Housing Inflation Pressures

Is Inflation Pressure Easing? Factory Input Costs Tumble Again

Abnormally Low Rates Remain Even If Fed Hikes in 2023

Americans Give Up on Inflation Remaining Tame

If Inflation Returns, Bond’s Diversification Power May Disappear

Essentially Nothing. That’s How Much Bonds May Return Over Next Five Years

It’s Getting Harder to Fund Retirement Using Bonds

 

This commentary is written by Horizon Investments’ asset management team. For additional commentary and media interviews, contact Chief Investment Officer Scott Ladner at 704-919-3602 or sladner@horizoninvestments.com.

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©2022 Horizon Investments LLC

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