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Fixed Income Monthly

Crit Thomas, CFA, CAIA, Erik M. Aarts, CIMA, Brian Cheyne, CFA, CIMA
Income Investing
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Fixed Income Monthly

  •  The economy expanded 3.3% in the last quarter of 2023 and grew 3.1% for the year with the consumer leading the way.
  •  Evidence continues to mount that the economy is coming in for a soft landing. Given full employment and little evidence of consumer strain, any recession, were it to occur, would likely be very shallow.
  • While the Index of Leading Economic Indicators posted its 22nd consecutive monthly decline and the ISM Manufacturing Index remained in contractionary territory, these indicators have not translated into an increase in unemployment nor a collapse in consumer sentiment.
  • Inflation continued to slow with the latest Core Consumption Price Deflator reading moving down to 2% quarter over quarter at an annualized rate, the latest sign consumer prices are progressing toward the Fed's 2% target.
  • And while wage growth has been sticky to the high side, the latest Employment Cost Index report suggests wages are moderating, reducing a potential risk that wages could keep inflation elevated.
  • The Fed left interest rates unchanged in January and signaled they would likely hold off cutting in March as well.
  • Certainly prior policy tightening will continue to work its way into the economy and could impact growth, but should inflation continue to come down it appears likely the Fed can pivot in time to catch the economy

  • After a big drop to end '23, Treasury yields kicked off '24 by moving higher as the market considered the potential impact of continued Federal government deficit spending and a rising national debt. Even though investors shrugged off those concerns by month end we will be watching for rate volatility around ongoing budget negotiations in Washington.
  • While increased government debt issuance along with surging private sector issuance should test investor appetite, anecdotal evidence shows surging demand for bonds of all types while the market waits for the Fed to pivot. 
  • Hopes for a March rate cut were dashed when Powell remarked March was too soon and that the committee intends to tread cautiously. Still, the market continues to price more cuts than indicated by the Fed's current median dot plot forecast. We expect to learn about the Fed's plans to taper QT in March. 
  • The yield curve, which has now been inverted between the 2-year and 10-year maturities for the longest period of time since the early '70’s, may not be signaling recession this time around, but rather that inflation will slow meaningfully.
  • We expect that interest in longer duration bonds will continue to increase in front of the Fed moving to lower rates later this year with longer-term yields settling at lower levels toward the end of year. 
  • The breathtaking fixed income drawdown these past three years is over. We believe that today's higher starting yields support better returns going forward allowing bonds to deliver income, diversification and capital preservation
  • After strong returns in late 2023 credit risk sensitive bonds posted mixed returns in January as yields crept higher and spreads were little changed. Shorter-maturities outperformed longer-maturities, while lower quality bested higher quality. 
  • New issuance exploded in January with over $200 billion in investment grade and high yield bonds issued. Investor demand for new issues was equally strong. Looking at the forward calendar this trend is expected to continue.
  • Absolute yields across the credit markets were little changed in January. Despite a modest decline in yields late last year, credit sectors remain near the high end of their 10 year range (see table page 4) and look attractive at these levels.
  • Credit spreads have generally moved lower over the past year in recognition that better economic growth may alleviate concerns about defaults. 
  • While we think corporate defaults may rise modestly in 2024, we do not expect a spike as we have seen in the past following rate hiking cycles. Corporate fundamentals, including lower balance sheet leverage, solid interest coverage, and little near-term refinancing pressure, remain supportive.
  • Rising prospects of a soft landing and an impending Fed pivot suggest good potential returns for credit risk sensitive bonds.

Fixed Income Indexes Characteristics

The Indexes mentioned are unmanaged statistical composites of stock market or bond market performance. Investing in an index is not possible.

For Index Definitions see: TouchstoneInvestments.com/insights/investment-terms-and-index-definitions

2021 – Pandemic continued in waves. Fed held rates near zero and continued to grow its balance sheet at a moderate pace. Long duration bonds sold off while Treasury Inflation Protected Securities rallied on inflation concerns. Exclusive of duration credit exposed securities generally earned their yield.
2022 – The Fed embarked on one of its most aggressive tightening paths seen in decades as the inflation rate surged well above their goal. Interest rates rose across all maturities leading to one of the worst years for fixed income returns.
2023 – Inflation fell broadly while the economy grew with the labor market and consumer spending resilient. The Fed paused midyear helping rates and credit spreads fall late in the year and turning returns positive for the year.

The Touchstone Asset Allocation Committee

The Touchstone Asset Allocation Committee (TAAC) consisting of Crit Thomas, CFA, CAIA – Global Market Strategist, Erik M. Aarts, CIMA - Vice President and Senior Fixed Income Strategist, and Brian Cheyne, CFA, CIMA - Senior Investment Strategy Specialist, develops in-depth asset allocation guidance using established and evolving methodologies, inputs and analysis and communicates its methods, findings and guidance to stakeholders. TAAC uses different approaches in its development of Strategic Allocation and Tactical Allocation that are designed to add value for financial professionals and their clients. TAAC meets regularly to assess market conditions and conducts deep dive analyses on specific asset classes which are delivered via the Asset Allocation Summary document. Please contact your Touchstone representative or call 800-638-8194 for more information.

A Word About Risk
Investing in fixed-income securities which can experience reduced liquidity during certain market events, lose their value as interest rates rise and are subject to credit risk which is the risk of deterioration in the financial condition of an issuer and/or general economic conditions that can cause the issuer to not make timely payments of principal and interest also causing the securities to decline in value and an investor can lose principal. When interest rates rise, the price of debt securities generally falls. Longer term securities are generally more volatile. Investment grade debt securities which may be downgraded by a Nationally Recognized Statistical Rating Organization (NRSRO) to below investment grade status. U.S. government agency securities which are neither issued nor guaranteed by the U.S. Treasury and are not guaranteed against price movements due to changing interest rates. Mortgage-backed securities and asset-backed securities are subject to the risks of prepayment, defaults, changing interest rates and at times, the financial condition of the issuer. Foreign securities carry the associated risks of economic and political instability, market liquidity, currency volatility and accounting standards that differ from those of U.S. markets and may offer less protection to investors. Emerging markets securities which are more likely to experience turmoil or rapid changes in market or economic conditions than developed countries.

Performance data quoted represents past performance, which is no guarantee of future results. The investment return and principal value of an investment in the Fund will fluctuate so that an investor’s shares, when redeemed, may be worth more or less than their original cost. Current performance may be higher or lower than performance data given. For performance information current to the most recent month-end, visit TouchstoneInvestments.com/mutual-funds.

Please consider the investment objectives, risks, charges and expenses of the fund carefully before investing. The prospectus and the summary prospectus contain this and other information about the Fund. To obtain a prospectus or a summary prospectus, contact your financial professional or download and/or request one on the resources section or call Touchstone at 800-638-8194. Please read the prospectus and/or summary prospectus carefully before investing.

Touchstone Funds are distributed by Touchstone Securities, Inc.*
*A registered broker-dealer and member FINRA/SIPC.
Touchstone is a member of Western & Southern Financial Group

Not FDIC Insured | No Bank Guarantee | May Lose Value

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