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January 2022

Shifting Dynamics in Taxable Fixed Income

Key Points

  • The Fed changed course and is projected to increase rates 4 times in 2022
  • Short-term rates are moving up more quickly than long-term rates
  • Floating rate sectors of high yield are poised to outperform

Treasury rates were volatile over the fourth quarter, but, on balance, long rates were stable. High-quality taxable bonds moved higher by just 0.01% 1. Fixed income credit valuations spent most of 2021 at historical highs, but risk repriced and became more attractive by the end of the quarter, reflecting the impact of the Omicron variant and a shift in policy normalization pace from the Fed. Rate liftoff was expected in late 2022, but the Fed has now shifted to 4 hikes as a base case.

On the U.S. Treasury front, 2-year, 3-year and 5-year notes moved up 0.49%, 0.43% and 0.30%, respectively, while the 10-year note remained unchanged and the 30- year note dropped 0.15% 2. This phenomenon is called curve flattening and tends to occur as the Fed increases short-term interest rates. Despite the stability in long rates, we expect the 10-year note to be within 2-2.5% by year-end. Higher short-term rates are positive for investors in conservative strategies, and our projected rate increases will not erode returns in high-quality fixed income strategies. We forecast returns in high-quality fixed income of 1.0% and recommend an overweight to high yield.


With high inflation and imminent Fed hikes, the landscape is changing within opportunistic income. We expect returns to fall slightly from 2021 levels, but are still projecting a 3-5% return range. As short rates rise, floating rate asset classes like leveraged loans and structured credit are the likely outperformers. Emerging Market High Yield will experience a bumpy ride in 2022. Now that policy accommodation is waning, the dollar could move higher, putting pressure on Emerging Market balance sheets. From its lows in May, the dollar has moved up 6.82%³ and, while stable in 2022, U.S.-based short term rates are significantly higher than global rates, which will cause cross-border flows into U.S. assets.

Volatility in rates and credit will create significant opportunity within taxable fixed income. We recommend utilizing episodes of weakness to reallocate into floating rate sectors of the high yield market.

1 LBUSTRUU Index: Bloomberg Barclays US Aggregate Bond Index

2 GT2 Govt, GT3 Govt, GT5 Govt, GT10 Govt, GT30 Govt: US Government Treasury Bonds

3 DXY Index: The U.S. Dollar Index

T Curve: a curve that shows the interest rate associated with different contract lengths for a particular debt instrument (e.g., a treasury bill). It summarizes the relationship between the term (time to maturity) of the debt and the interest rate (yield) associated with that term.

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