- Economic Resilience May Continue: We anticipate U.S. economic growth to slow next year, but still beat current consensus expectations, driven by continued consumption and potentially better capital spending.
- Potentially Sticky Inflation: We anticipate moderating price increases but expect inflation to remain above the Fed's target. Recent reports show inflation stuck in the 2–3% range. Uncertainty around tariffs and deportations could influence this outlook.
- Fed Normalizing Rates: The Fed is not "easing" to stimulate the economy but rather "normalizing" interest rates to balance full employment and price stability. Given the economy's current resilience, strong household finances, and potential policy shifts from the incoming administration, we expect the neutral rate to be much higher than in the previous cycle.
- Housing Market Stuck: Mortgage rates have risen since the Fed began normalizing rates, while home prices remain elevated due to a lack of supply. Homeowners are staying put and housing affordability remains depressed. The housing market, an important engine of the economy, may remain stuck absent a sharp slowdown and significantly lower interest rates.
- Proceeding with Caution: With the election behind us, we are assessing how tax, trade and immigration policies might impact growth, inflation, and markets.
- Reducing Rate Risk: Following the election, we shifted to a slight duration underweight, anticipating a higher yield environment under a potential GOP sweep. We see the risk of higher yields driven by inflation concerns and unsustainable government spending.
- Significant Challenges Ahead: The next Treasury team will face significant challenges. The debt ceiling will be reached in January, and the team inherits a $2 trillion annual deficit while needing to fund $6 trillion in promised tax cuts over ten years. Current interest on the debt is more than 18% of tax revenue. With mandatory spending, interest costs, and defense comprising $5 of every $7 spent, identifying sufficient offsetting savings to fund tax cuts will be difficult.
- Term Premium Watch: Longer-maturity Treasury yields could stabilize in the near term. While Congress addresses the debt ceiling no new debt will be issued, reducing supply. Additional rate cuts and the end of quantitative tightening could temporarily ease pressure on the term premium.
- Fed Not in a Hurry: Meeting minutes indicate officials favor a gradual approach to further cuts and remain uncertain about the neutral rate's level. The market expects just three cuts next year, which could keep bond yields elevated.
- Appealing Yields: High-quality bond yields remain near the high end of their 10-year range. Higher-coupon, intermediate-maturity bonds are less sensitive to interest rate changes, potentially supporting returns even if long-term yields rise modestly in the new year.
- Overweight High Yield: High-yield bonds have performed well despite rising interest rates, supported by economic resilience, a lower maturity wall, and higher index quality. We believe additional Fed rate cuts could prompt investors to shift into higher-yielding securities.
- Pending Policy Support: It is too early to tell whether trade and immigration policies will benefit or hinder corporate America. However, credit markets remain optimistic that deregulation and tax cuts could bolster profit margins and earnings. Tight credit spreads narrowed further after the election.
- Consumer Health: The strength of consumer finances is critical to supporting further gains across securitized credit sectors. Spreads have tightened toward corporate credit, while yields remain attractive. Sustained job and wage growth will be key to realizing those yields.
- Active Management Key: Policy changes may create both winners and losers in securitized and corporate credit markets, presenting opportunities to generate returns and manage risk effectively.
- Earnings Watch: With expensive starting valuations, earnings growth is crucial. While 2025 earnings expectations for the S&P 500 have declined modestly, solid growth is still anticipated. Should those expectations change, we would reassess our credit positioning.
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
