How to get a 6% bond yield this year, according to the Guggenheim

According to Guggenheim Partners, after a terrible year, investors have a simple strategy that allows them to make about 6% returns in the bond market.

The rapid pace of interest rate hikes by the Federal Reserve since March have penalized investors in both stocks and bonds, but the central bank’s efforts appear to be paying off, at least as far as inflation is concerned.

This is an important reason why the Guggenheim now expects high-quality bonds to yield almost 6% in 2023.

The team examined the initial returns of this year’s benchmark Bloomberg US Aggregate Bond index, known as “Agg”, and compared it to the annual returns (see chart) over the past 20 years. This suggests that Agg could generate around 6% of total profits in 2023, the best performance since 2008.

The Guggenheim economist sees a yield potential of around 6% this year for the ‘Agg’ benchmark bond index.

Guggenheim Investments, Bloomberg

“The Fed’s cycle of aggressive tightening resulted in a painful reset of bond yields in 2022, but the result was that the central bank moved ‘income’ back into fixed income, thereby improving its yield outlook,” Brian Smedley, Chief Economist, and his team. at the Guggenheim wrote in a new client note.

To be sure, Agg’s more than -10% negative returns in 2022 have entered the history books. But iShares Core US Aggregate Bond ETF, AGG,
-0.15%
which tracks the benchmark was already up 3.2% year-over-year through Friday, while the S&P 500 SPX index,
+0.25%
rose 6% over the same period, according to FactSet.

The higher cost of borrowing is intended to keep costs down for consumers and businesses, helping the Fed keep inflation in check, ideally without triggering a recession.

The US inflation gauge, the Fed’s preferred PCE index, on Friday showed a further easing in price pressures in December to 5% year-on-year from a peak of 7% last summer, potentially opening the door for the Fed to stop raising interest rates soon.

Fed officials are expected to raise rates by 25 basis points less next week. The Fed funds rate is currently in the 4.25-4.5% range, the highest since 2007.

While many expect a recession in 2023, recent economic data is encouraging that it can be avoided. It also leaves investors wondering how long the Fed may need to keep rates high for inflation to return to its 2% annual target.

Benchmark 10-year Treasury yield TMUBMUSD10Y,
3.488%
It topped 3.5% again on Friday, after climbing to 4.2% in October, according to Dow Jones Market Data. Bond prices and yields move in the opposite direction.

If the US falls into a recession, the Guggenheim team also sees a positive side to bonds, as they “could boost yields even more if investor flight to safety lowers bond yields.”

See: ‘Times can’t get any worse’: Inflation may be slowing, but people say it’s getting harder to cover contingencies — and the next Fed meeting won’t help

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