Pause for Effect

October 19, 2023 | Nic Solecki, CBDA, Associate Research Analyst

This chart description is for illustrative purposes only and its accuracy cannot be guaranteed. Please see full disclosures at end of PDF document in the web post. General description: Two-line chart highlighting historical rate cycles and fed funds rate and bond index returns. Chart subtitle: Fixed income performance has typically been robust during pause cycles that follow rate increases. Chart source: Bloomberg as of September 30, 2023. Chart description: Y-axis is labeled “Policy Rate and 1-Year Total Return” and ranges from -20% to +40%. X-axis is labeled in full yyyy format, in 5-year increments, from 1983 to 2023. Pause cycles are shaded in light green. Federal Funds Rate – Upper Bound is plotted in light blue line. U.S. Aggregate Bond Index is plotted in dark orange line. Please contact us for the full dataset. End chart description. See disclosures at end of document.

With higher rates dragging on performance, investment grade fixed income securities experienced a challenging third quarter. While September CPI data may lead to a final rate increase by the Federal Reserve before the end of the year, a tactical pause by the central bank in the months following the next FOMC meeting appears likely. Based on prior pause cycles, investors may have reasons for optimism as it relates to the trajectory of investment grade fixed income in the near future.

The chart above highlights policy rate pause cycles overlayed with 1-year trailing returns of the Bloomberg U.S. Aggregate Bond Index and the upper bound of the federal funds rate over the last 45 years. For this analysis, a pause cycle was defined as a period immediately following a rate hike during which the policy rate was maintained at a single level for more than two consecutive FOMC meetings. As rate policy is dictated by economic data, looking beyond two FOMC meetings helps to distinguish pause cycles from stair-step rate increases. Based on this framework, there have been 13 such cycles since 1980, which have lasted roughly six months on average.

In Marquette’s most recent Quarterly Letter from the Director of Research, Halftime Adjustments, it was suggested that the overall yield environment, coupled with fewer Fed rate hikes going forward, could generally serve to benefit the fixed income space. This optimism is supported in part by the relatively strong bond market performance observed during 12 of the 13 pause cycles detailed above, with the lone exception coming in 1983 and 1984. This pattern aligns well with intuition, as a flat rate environment allows investors to collect coupon payments from bond holdings while prices hold steady, which leads to positive returns. Investors should remember, however, that the differences between past environments and current realities must be considered when assessing the return potential of all asset classes, including fixed income. While past performance does not guarantee future returns, Marquette will be watching closely to see if trends similar to those outlined above unfold over the coming months.

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