Conservative Means the Right Fixed Income Allocations & Quality

Conservative Means the Right Fixed Income Allocations

• At their March meeting, the Federal Open Market Committee raised the Fed Funds Target Rate by 25bps (0.25%-0.50%). Citi’s CIO believes the Fed will raise rates at each meeting – first by 50bps followed by 25bps each – as Quantitative Tightening begins.
• Powell stated that “no matter what happens”, the Fed is determined to prevent high inflation from becoming entrenched in the economy and also noted that the job market has tightened to an “unhealthy level”. This implies that the Fed is determined to reduce inflation and is fine with the job market cooling off and the asset markets less frothy.
• The 2y-10y curve has flattened about 120bp over the last six months as Fed hikes have been priced-in. As a result, the Global Investment Committee has raised inflation hedge assets, including 4% in natural resources and oil services, a 2% gold, and 1% TIPS overweight. 
• Conservative portfolios will also shift toward quality bonds now that their yields are higher on the Fed’s sharp “about face.” US 5-year Treasuries provide 98% of the yield of 30-year “long bonds” with almost one-sixth the duration risk. With both intermediate- and long-term rates having posted 170- and 50-basis point increases, respectively, over the last 12 months, the CIO team would begin to look favorably on adding a longer-duration position to balanced stock/bond portfolios as a risk hedge if 10-year yields rise above 2.5%

• The recent drawdown in the Treasury market has made high-quality US municipal bonds (munis) more attractive relative to Treasuries. This year, the 5y M/T ratio rose from about 45% to around 77% while the 10y ratio has risen from about 70% to 89%. For investors who believe Treasury yields are nearing a cycle peak, these ratios suggest a window of opportunity.
  
   

Conservative Means Quality

• Quality is an important consideration at this moment. CIO’s thematic overweight to consistent dividend growers has translated into stable returns this year. These shares have the potential to produce smaller losses in stressed markets but may underperform in ROBUST ones. However, dividend growers may have more return per unit of risk as demonstrated historically. The potential for long-term outperformance for patient quality-dividend investors is valuable during times like these.