The Federal Reserve is likely to keep cutting interest rates into 2025, providing intriguing opportunities for investors seeking solid yields—if they know where to look. Predictions point toward a quarter-point rate cut following the Fed’s policy meeting next week. According to the CME FedWatch tool, there’s a good chance this cut will be followed by a pause in January, marking the third reduction in this cycle.
This shift is already affecting cash investments, with the Crane 100 Money Fund Index showing a seven-day yield of 4.43%, a noticeable drop from 5.13% in late July. Dominic Pappalardo, Morningstar’s chief multi-asset strategist, suggests it’s a strategic moment for investors to revisit the role of fixed-income allocations in their portfolios. “Now’s a great time to transition cash from the sidelines into longer-term fixed-income assets,” he advises.
Pappalardo highlights two key advantages to adding longer-dated assets. First, they can offer a positive real yield, which is the yield after accounting for inflation. Second, these assets act as a hedge against market downturns, providing appealing interest income with the potential for price appreciation as interest rates fall. It’s important to remember that bond prices and yields move inversely, and those with longer durations are more sensitive to interest rate changes, known as duration sensitivity.
In pursuit of strong yields, Pappalardo mentions that a fixed income portfolio with an intermediate duration of three-and-a-half to six years strikes a reasonable balance between risk and return. Meanwhile, specific fixed-income sectors are presenting attractive opportunities. For instance, Vishal Khanduja of Morgan Stanley Investment Management points to agency mortgage-backed securities as a promising option within the fixed-income market. As a manager of the Eaton Vance Total Return Bond ETF (EVTR), Khanduja remarks, “We believe the fundamentals here are solid.”
Khanduja also sees value in bank loans. While these loans are often below investment grade, they’re secured by borrowers’ assets, offering a priority in payment if a borrower defaults. “With the Fed not raising rates and current rates favorable, these loans present an interesting prospect,” Khanduja explains, noting that lower rates could benefit borrowing companies.
Exploring beyond the U.S., emerging markets debt offers another avenue for earning additional yield, according to Pappalardo from Morningstar. He suggests incorporating a modest amount of this asset class for diversification benefits. “Emerging markets, though below investment grade, offer appealing real yields,” he notes, citing Brazil and Mexico as countries with competitively high bond yields relative to their inflation rates, providing a margin of safety for investors.
Despite the appeal of certain fixed-income segments, Pappalardo urges investors to prioritize quality within their portfolios and avoid the lure of higher yields at the expense of credit quality. “It’s essential to maintain quality in fixed income to support portfolio stability during volatile times,” he advises, warning that riskier assets could offset potential hedging advantages. Fixed-income allocations should serve as a steadying force, helping portfolios withstand market turbulence with greater stability.
