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Fixed income investors ask: Where to from here?

For much of 2018, investors were bracing for negative absolute returns from their fixed income portfolio given the likelihood of higher interest rates and continued monetary policy tightening. Yet as volatility spiked in the fourth quarter and bond investors pushed back forcefully against the Fed’s forecast by driving yields lower, many fixed income indices posted positive returns for the year. That’s the good news.

But where to from here? Or rather, is a recession truly imminent as some pundits are warning? That’s the real question dogging many investors.

For clues, it might help to consider how we ended 2018. A plethora of factors contributed to a dramatic shift in sentiment late in the year. Some investors have been wondering if the Fed would be too vigilant for too long. Fed Chairman Powell made comments in early October suggesting monetary policy was a “long way from neutral” despite the steady rate increases implemented throughout 2018. These incited fears of a Fed policy error and the increasing likelihood of a recession. Subsequently, the Fed did reduce its 2019 outlook for rate increases from three to two moves, though nothing is certain and the Fed remains committed to staying flexible depending on the data.

Compounding matters has been a tenuous U.S./China trade relationship, an apparent slowing of global growth, and political chaos in Washington and the EU given the uncertainty surrounding Brexit negotiations. Despite some more recent positive news—including a 90-day trade truce with China, an OPEC agreement to cut oil production and a softer tone from Fed chair Powell—credit spreads remain relatively wide and the front end of the yield curve inverted.

If that weren’t enough, fixed income investors are also wondering if cash will be a viable competing asset class looking out into 2019. Not long-ago investors earned virtually nothing on cash balances, yet today they can earn in the 2-to-2.5% range with little duration or credit risk. This could be attractive to risk-averse investors if volatility remains elevated or even increases. For perspective, 3-month Treasury bills now have a higher yield than the dividend yield on the S&P 500 Index.

Ultimately, we expect economic growth to slow back towards 2% in 2019 as the marginal benefits from fiscal stimulus (tax reform) and deregulation fade. Trade uncertainty is also likely to slow business investment, while tighter financial conditions resulting from volatile equity markets and higher interest rates could further impact sentiment and spending. With that said, we do not expect to see a recession in the U.S. in 2019, but we do see rising risks for 2020 if the Fed continues to raise rates on its current path and if there is not a positive resolution to the U.S.– China trade relationship soon.

For INCORE, we believe an up in quality bias is prudent for the coming year. Yield curve positioning and duration continue to be a critical focus and will be opportunistically managed based upon our proprietary trading signals, as well as our assessment of the Fed’s communications and actions.

Victory Capital, Inc. is a Registered Investment Advisor. The information in this article is based on data obtained from recognized services and sources and is believed to be reliable. Any opinions, projections or recommendations in this report are subject to change without notice and are not intended as individual investment advice. Not to be used as legal or tax advice.

©2019 Victory Capital Management Inc.
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Investments involve risk including possible loss of principal. The value of the equity securities in which the fund invest may decline in response to developments affecting individual companies and/or general economic conditions. Dividends are never guaranteed. International investing involves special risks, which include changes in currency rates, foreign taxation and differences in auditing standards and securities regulations, political uncertainty, and greater volatility. Emerging markets involve heightened risks related to the same factors as well as increased volatility and lower trading volume. You may lose money by investing. There are no guarantees the funds will achieve their investment objectives and strategies may be unsuccessful.

Investments in bank loans may at times become difficult to value and highly illiquid; they are subject to credit risk such as nonpayment of principal or interest, and risks of bankruptcy and insolvency. Fixed income securities are subject to interest rate, inflation, credit and default risk. The bond market is volatile. As interest rates rise, bond prices usually fall, and vice versa. The return of principal is not guaranteed, and prices may decline if an issuer fails to make timely payments or its credit strength weakens.

ETFs have the same risks as the underlying securities traded on the exchange throughout the day. Redemptions are limited and often commissions are charged on each trade, and ETFs may trade at a premium or discount to their net asset value. There can be no assurance that an active trading market for shares of an ETFs will develop or be maintained. The ETFs are not actively managed and may be affected by a general decline in market segments related to the Indexes. The ETFs invest in securities included in, the Index, regardless of their investment merits. The performance of the ETFs may diverge from that of the Indexes. 

Fixed income securities are subject to interest rate, inflation, credit and default risk. The bond market is volatile. As interest rates rise, bond prices usually fall, and vice versa. The return of principal is not guaranteed, and prices may decline if an issuer fails to make timely payments or its credit strength weakens.

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Victory Capital means Victory Capital Management Inc., the investment manager of the USAA Mutual Funds and VictoryShares USAA ETFs. Victory Mutual Funds and USAA Mutual Funds are distributed by Victory Capital Advisers, Inc. (VCA). VictoryShares ETFs and VictoryShares USAA ETFs are distributed by Foreside Fund Services, LLC (Foreside). VCA and Foreside are members of FINRA and SIPC. Victory Capital Management Inc. (VCM) is the investment adviser to the Victory Mutual Funds, USAA Mutual Funds, VictoryShares ETFs, and VictoryShares USAA ETFs. VCA and VCM are not affiliated with Foreside. USAA is not affiliated with Foreside, VCM, or VCA. USAA and the USAA logos are registered trademarks and the USAA Mutual Funds and USAA Investments logos are trademarks of United Services Automobile Association and are being used by Victory Capital and its affiliates under license.

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