We offer our Fixed Income Team’s 2012 economic outlook, with reassurances and recommendations for those concerned about rising interest rates and inflation. We generally suggest that investors who are most concerned about these threats consider short-duration diversified or inflation-protected securities strategies.
We believe there’s little question that U.S. interest rates, bond yields, and inflation are more likely—in the long run—to rise than decline further. That’s normal, especially following an extended period in which the U.S. Federal Reserve has kept short-term interest rates artificially low.
As investors and advisors anticipate higher interest rates and inflation, they’ve been asking us when the increases might occur, what their magnitude might be, and about their impact on fixed income investments.
“Bond Bubble” Déjà-vu
We’ve experienced similar waves of concerns, most notably in the fourth quarter of 2010. That’s when we addressed a crescendo of “bond bubble” fears, following 30 years of bond outperformance, two years of investor inflows directed primarily toward bond funds, and increasing economic optimism.
We would still suggest now, as we did then, that near-term “bubble” fears might be overblown, based on our Fixed Income Macro Strategy Team’s assessment of global economic conditions, U.S. investor demographics, and global safe-haven and central bank demand for U.S. government securities.
Even looking longer term, we continue to believe that certain core, diversified, intermediate-duration fixed income vehicles possess fundamental attributes that can help investors withstand interest rate shocks better than investors assume, particularly within long-term buy-and-hold strategies. For investors particularly concerned about (or sensitive to) rising interest rates and/ or inflation, we generally suggest that they consider shorter-duration diversified or inflation-protected securities strategies.
Global Growth Dichotomy
Our near-term anti-“bubble” arguments remain based, in part, on our global economic outlook for this year. We believe there’s still too much economic slack for growth to inflate prices and interest rates to pre-recession levels in 2012.
Some slack stems from what we call the “growth dichotomy” between the consumer and business sectors. Our research models show that consumer sector growth significantly lags that in the business sector.
Our Macro Strategy Team has assigned its highest outcome probability to a subpar economic growth scenario, in which U.S. growth would remain between 1–3% in 2012, hampered by the housing market, unemployment, unsettled conditions in Europe and the Middle East, and oil prices. We think growth constraints on global demand for resources and labor should keep inflation contained at a moderate level.
Realistic Expectations, Appropriate Portfolio Positioning
Let’s be clear—we don’t expect 2012 to be another bond performance year on par with 2011. We believe last year’s bond rally was pre-staged by over-optimistic growth expectations at the end of 2010 and early 2011, which pushed the 10-year Treasury yield above 3.7% before it plunged below 2% later in the year.
We believe mixed signals and lingering economic and political uncertainties generally make the case for a disciplined, diversified, long-term investment approach, in which we strongly favor diversified, intermediate-duration investments for fixed income positions. Our research indicates intermediate-duration vehicles show the most compelling historic risk-return behavior, particularly within long-term buy-and-hold portfolios. But for investors with shorter investment time horizons and/or less interest-rate or inflation risk tolerance, we suggest they consider shorter-duration diversified or inflation-protected securities strategies.
The opinions expressed are those of G. David MacEwen and are no guarantee of the future performance of any American Century Investments portfolio.
For educational use only. This information is not intended to serve as investment advice.