Diversification & Stability: The Case for Fixed Income
Posted on February 5, 2025
Over the past decade, when interest rates were hovering near zero, fixed income was not a focal point for most client portfolios at The Trust Company – and rightfully so. However, in 2022, the United States experienced an unprecedented surge in inflation, prompting the Federal Reserve (the Fed) to raise interest rates to 5.5%, a 16-year high.
Fast forward to today—as inflation has cooled from its peak of 9.1% in June 2022 to 2.9% in its December Consumer Price Index (CPI) report, the Fed has recently pivoted to easing short-term rates, to support continued economic growth and stability within financial markets.
That said, the economic and political landscape continues to evolve and provide mixed signals, which the bond market is struggling to parse. GDP and job growth have been volatile lately, but the general trend is one of deceleration, while other measures such as retail sales and jobless claims continue to demonstrate resiliency. Inflation, despite the meaningful progress toward the Fed’s 2% target, has proven to be “sticky”, leading the Fed to strike a more cautious tone during its December meeting, adjusting its 2025 projection from four interest rate cuts to two.
Additionally, the bond market will need to evaluate the incoming administration’s policies, which while still light on details are inherently inflationary in nature — tariffs, immigration restrictions, and tax cuts could all fuel fresh price pressures. This interpretation has been reflected in long-term yields, which post-election have risen to near the highs of the year.
While these longer-term rates remain elevated, it is an opportune time to review your fixed income allocation. Even though yields are down modestly from the highs we saw in May 2022, at The Trust Company we can source Treasury, corporate, or municipal bonds at attractive levels for medium-term maturities. For example, yields on corporate bonds can still offer your portfolio 4.5-5.5%, and municipal bonds can offer absolute returns over 3%.
Beyond these currently compelling yields, fixed income assets also play a broader and vital role in balancing risk and return in portfolios. While stocks often capture the spotlight due to their higher growth potential, fixed income securities offer ballast against the also higher volatility of equity markets. Bonds provide steady and predictable cash flows, typically paying interest two or four times per year, and the return of principal at maturity.
Accordingly, their prices will be less reactive and sometimes move in the opposite direction to the equity market. This is the diversification benefit of fixed income – its low or sometimes negative correlation with the stock market – which can lower the overall volatility of the portfolio. During periods of acute market uncertainty, investors often turn toward bonds as a “safe haven” asset, driving bond prices higher on increasing investor demand. We have seen this dynamic throughout history, most recently during the banking crisis of March 2023, COVID in 2020, the Euro crisis of 2011/2012, and ironically, the U.S.’s own debt rating downgrade in 2011.
Following a historic bull market run, and as equities hover at historically high valuations, we at The Trust Company think it prudent to consider adding fixed income to your portfolio, and realize the benefits of income, stability, and diversification. Our investment management team is available to review your portfolio and discuss the most appropriate allocation for you. Contact us today for a consultation.
Miles Toth
Portfolio Management
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