As the US economy cools and central banks approach the end of their hiking cycles, CIO thinks it's time to lock durable income into portfolios. (UBS)

With press reports on debt ceiling negotiating progress and an end to Fed rate hikes within sight, we advise investors to find more durable sources of income, including in longer-duration fixed income, equity markets, real assets, and structured investments.

Cash and money market funds have become more appealing recently.

  • The yield on the 1-month and 3-month US Treasury recently climbed to the highest level in over 20 years, due to more hawkish rhetoric from top Fed officials.
  • Dallas Fed President Lorie Logan said that the latest economic data did not yet justify a pause in rate hikes in June.
  • Default risks surrounding the US debt ceiling have also contributed to higher rates.

But we believe the attraction of cash is likely to prove short-lived, and investors should lock in durable income.

  • Our base case for an agreement on the debt ceiling ahead of the 1 June X-date.
  • Moderating default risks already started to push the yield lower on the 1-month US Treasury, down 22bps from a two-decade intra-session high last week.
  • Despite recent indications that a Fed rate hike in June remains possible, an end to the cycle is not far away, and our base case remains that the central bank will not raise rates any further.

We think it's time to add exposure to bonds.

  • Instead of focusing on the ultra-short end of the yield curve, we see opportunities in high-quality medium- to long-duration fixed income.
  • Investors can also find attractive income opportunities in equity markets, through high-dividend and quality stocks.
  • Real assets along with yield generating structured investments offer alternative ways to add durable returns.

Did you know?

  • The Federal Reserve raised interest rates by a 25 basis points at its 2–3 May meeting. This took US borrowing costs to the highest levels in 17 years, with a fed funds target range of 5–5.25%.
  • While yields on 2- and 5-year US Treasuries are down from their recent peak in early March—which was prior to the emergence of worries over the health of the banking system—yields remain attractive, at 4.24%and 3.66%, respectively, as of 22 May.
  • The MSCI World High Dividend Yield index is offering 4.2% yield. These equities are mostly in more defensive parts of the markets and are relatively resilient when the economy slows—as we expect these dividend payments to be relatively stable even in the event of a recession, based on historical experience.

Investment view

With recent events suggesting that policy rates may peak earlier than anticipated, we think investors should act to add durable income to portfolios. including through longer-duration fixed income, equity markets, real assets, and structured investments.

Main contributors - Christopher Swann, Vincent Heaney, Matthew Carter

Content is a product of the Chief Investment Office (CIO).

Original report - Where can I find portfolio income?, 23 May 2023.