Coming into 2021, we expected Treasury yields to move higher.
And they did. Higher inflation expectations, less involvement in the bond market by the Fed, and a record amount of Treasury issuance were all reasons we thought interest rates could end 2021 between 1.50% and 1.75%. For 2022, near-term inflation expectations above historical trends and improving growth expectations once the Delta variant recedes are reasons why we believe interest rates could move moderately higher from current levels. In 2022, we expect the 10-year Treasury yield to end the year between 1.75% and 2.00%.
However, an aging global demographic that needs income, higher global debt levels, and an ongoing bull market in equities (which potentially means more frequent rebalancing into fixed income) may keep interest rates from going much higher in 2022.While we don’t expect interest rates to move much higher next year, because starting yields for core fixed income are still low by historical standards, returns are likely to be flat to the low-single digits in 2022. Not a great year but we should see an improvement over the negative fixed income returns we have seen in 2021.
The role of fixed income
With long-term interest rates close to what we think will be cycle highs, it’s important to revisit the case for fixed income within a broader asset allocation. Core bonds have historically provided capital preservation, diversification, and liquidity to portfolios, which we think are important portfolio construction objectives and help clients remain committed to their investment goals. With the economy likely transitioning to mid-cycle, the need for high-quality bonds increases in our view. Moreover, the need to offset potential equity market volatility remains an important role for core fixed income.
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Securities and advisory services offered through LPL Financial, a Registered Investment Advisor. Member FINRA/SIPC. Longleaf Wealth Management Group, LLC and LPL Financial are separate entities.
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