- The U.S. economy is showing signs of slowing but remains largely stable due to ongoing consumer spending and capital investment, particularly in AI. We are monitoring whether the small cracks in the economy might widen, potentially signaling a recession, but our base case remains a soft landing.
- Disinflation continued in August, with most reports coming in better than expected. The Core PCE Index has slowed to 2.6% year-over-year. We believe this downward trend will persist, although inflation is likely to remain above the Federal Reserve's 2% target well into next year.
- Job growth is clearly decelerating, with rolling averages moving into more moderate territory. In July, the economy added only 114,000 jobs. Wage growth is also beginning to moderate. While we believe the labor market is normalizing, we are watching closely as there is a risk it could deteriorate more quickly.
- The housing market remains weak as high mortgage rates and rising home prices dampened demand. However, with recent declines in mortgage rates, there is potential for modest recovery, although housing affordability remains a concern.
- The combination of slowing inflation and moderating job growth suggests that the risks to the Fed’s dual mandate are becoming more balanced, allowing for policy adjustment. Chair Powell reinforced this idea in his speech at Jackson Hole, stating, “The time has come for policy to adjust.”
- We expect the Fed to ease at their September meeting and gradually move interest rates toward a neutral range, which we estimate to be around 3.0-3.5%. This could help stabilize the economy before any cracks deepen, potentially supporting the financial markets.
- Improved inflation figures and softer employment data fueled a continued rally in high quality fixed income in August. Treasury yields have returned to levels last seen at the start of the year. We believe there are still moderate gains to be made if the economy slows as we expect.
- The yield curve has begun to un invert with short rates falling more than long rates recently as the fixed income market anticipates that the Fed will start cutting interest rates in September and continue easing through the rest of the year and into next year.
- As a result, the spread between the 2 year and 10 year Treasury yields is nearing positive territory for the first time in over 2 years. We wouldn’t be surprised to see the curve flip to a positive slope as the policy rate decreases.
- Reinvestment risk is at a critical point, as short-term yields, like Treasury Bills, tend to follow the Fed funds rate. While the recent drop in intermediate and long-term yields has marginally reduced additional potential returns, our research indicates that those who invest before the Fed begins cutting rates still see solid returns over the near term.
- We have slightly reduced our exposure to investment grade bonds in favor of an increase in high yield bonds. However, with yields still at levels not seen since before the Great Financial Crisis, we remain confident in high quality fixed income and anticipate potential additional returns.
- Considering the Fed's shift in tone may lead investors to move away from the front end of the curve towards higher-yielding securities, we moved to a slight overweight to high yield bonds.
- We recognize the increased risk associated with high yield bonds, particularly if the economy slows more than expected. However, our base case is for a soft landing, and we view the high yield market as being of higher quality than in the past. We also believe the Fed has ample room to respond to weaker economic conditions.
- Corporate and securitized credit markets rallied in August as yields dropped significantly, driven by expectations that Fed rate cuts will prevent the economy from stalling.
- Although spreads widened briefly at the start of the month due to a weaker than expected jobs report, they quickly rebounded in the following days. By month end, spreads had generally returned to their initial levels.
- We interpret the tight spreads as an indication the market anticipates continued healthy corporate earnings and that strong fundamentals will continue to support credit risk. While we believe corporate fundamentals remain solid, we are closely monitoring changes in earnings expectations.
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
