Strategic shifts: Optimizing fixed income as the Fed’s hiking cycle ends

In response to high inflation, the US Federal Reserve (Fed) significantly raised the fed funds rate eleven times from March 2022 to July 2023, reaching 5.25% to 5.50%, which made short-term investments more attractive. As the Fed indicates that rates have peaked and potential cuts could occur in the near future, investors are reassessing their fixed income allocations.

An analysis of historical fed funds rate peaks reveals that these often precede prolonged pauses or rate cuts. Examining fixed income returns from periods surrounding these peaks demonstrates that ultrashort, short-term, and intermediate core bonds typically underperform cash prior to rate cuts but tend to outperform afterward, especially with longer-duration bonds.

Despite the Fed's aggressive rate hikes this cycle, current performance trends are aligning with historical patterns. Consequently, this may be an opportune time to consider investments in ultrashort, short-term, and core bond strategies, as they have historically outperformed cash following shifts in Fed policy.