We believe now is the time to spend marginal dollars on helping to shore up your fixed-income flank—the part intended to help protect your portfolio against additional or elevated volatility as well as future recessionary conditions. We’re not calling for a recession yet. But there are a number of concerning signs indicating that asset markets will face continued challenges, at least in the immediate term. 

Four Reasons to Think Defensively in Fixed Income

1. Increased volatility and tighter financial conditions. As indicated in FIGURE 1, looking at the normalized volatility of the 1-year/10-year portion of the curve (i.e., 10-year rate, one year from now), we see that volatility levels have increased to levels higher than during the pandemic. The higher this metric, the higher is the market uncertainty on where the forward 10-year rate will be 12 months from now.
   

2. A relentless Fed: Financial conditions continue to tighten in the US economy. In prior years, such a tightening would have slowed the Fed’s path to less accommodative monetary policy. That’s not the case this time, with the latest Fed guidance looking through the current weakness in financial conditions. With several additional rate hikes expected in the next 12 months (including the probability of some multiple hikes in a month) a great deal of hawkishness is now priced into the forward curve. Going forward, the Fed will have to outperform those expectations for the markets to determine whether there will be additional upward policy-driven rate shocks. While there’s certainly room for additional upward pressure on rates (and given the volatility that we are seeing, one shouldn’t be surprised), the pace of rate increases may slow. 

While there’s certainly room for additional upward pressure on rates, the pace of rate increases may slow.

3. A flattening yield curve portends a gathering storm for the US economy. Some market participants state that this time is different, and it very well may be, but the debate continues to play out across capital markets.

   While market participants might notice the flatness of the short end of the Treasury curve vs. its 10-year and 30-year points, astute watchers of the curve will notice that forward-rate curves were already inverted prior to the latest flattening move.

   Given the strong position of the US economy and the less-leveraged nature of its consumers (relative to 2007), we believe it’s still too early to call a recession. The market is suggesting that if the Fed executes the currently priced-in rate hikes, we could be facing a scenario in which aggregate demand drops enough that the Fed would need to cut rates. Given the high volatility, we expect the curve to steepen and flatten in varying periods, but it’s important to note the initial inversion has taken place—even if the curve normalizes in the near term.

4. Sentiment grows weaker, as the US consumer, while having less debt, is faced with the challenge of navigating inflation in core areas such as housing/rent, energy, and food. Despite high consumer savings, this will eventually weigh on disposable income and consumption.  

Despite high levels of consumer savings, housing, energy, and food inflation will eventually weigh on disposable income.

Considerations For Adjusting Fixed-Income Allocations

1. Look to fixed-income strategies that may benefit from interest-rate and foreign-exchange volatility. These are predominately global rates and currency strategies that have wide flexibility, utilize relative-value metrics, and historically have provided the lower downside volatility that you expect from fixed-income allocations. In our view, Hartford World Bond Fund has proven itself in periods of market turmoil.

2. Consider adding duration in 2022. Rates are likely to move higher from here, allowing for potential entry points to traditional high-quality core fixed-income allocations (e.g., Hartford Total Return Bond Fund, Hartford Total Return Bond ETF, Hartford Core Bond ETF, and/or Hartford Municipal Opportunities Fund and Hartford Municipal Opportunities ETF for tax-sensitive investors). In our view, these could help investors add some duration with high-quality fixed income.
   
   
3. Low-volatility carry-credit strategies could complement your strategic credit allocations. This includes allocations to funds such as Hartford Short Duration Fund, Hartford Short Duration ETF, or Hartford Floating Rate Fund. Pairing these allocations with a strategic-income allocation (e.g., Hartford Strategic Income Fund) that can rotate into dislocated sectors while still providing opportunity for yield may also make sense. 

Fixed-Income Mutual Fund and ETF Strategies