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Fixed-Income Sectors Rise in the Third Quarter

Fed policy shift sets the stage for years to come.

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The Federal Reserve announced a major policy shift on Aug. 27, 2020, that will allow average inflation to “overshoot” the 2% target rate that had been in place since 2012. U.S. government-bond yields rose following the news. It’s important to note that the personal consumption expenditures price index, the Fed’s favored inflation metric, has rarely topped that 2% target rate under the prior framework. Near-zero interest rates are also expected to remain for the next several years. This is a change to the Fed’s historical tendency to lift interest rates to manage rising inflation that can be brought on by a hot labor market. The pandemic, and the structural changes that have come with it, has certainly thrown a wrench into this equation. It is the Fed’s hope that this policy change will support the labor market and broad economy.

As markets stabilized and both hiring and economic activity picked up from their March and April lows, inflation steadily rose. With this, real yields (nominal yields less inflation) fell even further into negative territory. The rise in inflation sent Treasury Inflation-Protected Securities, also known as TIPS, higher (3%) for the quarter. Inflation can erode the purchasing power of future interest and principal payments, ultimately reducing the value of an investor’s income stream. The rise in inflation and increasingly negative real yields, coupled with low interest rates, pushed investors further out on the risk spectrum in search of income.

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Zachary Patzik does not own shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.