- Softer Landing: Economic uncertainty fueled by government policy has negatively impacted sentiment and is beginning to creep into the hard data, such as consumer spending. While our baseline scenario continues to forecast a soft landing for the U.S. economy, the likelihood of a more turbulent landing is increasing. Accordingly, we have dialed back pro-cyclical risks in our asset allocation models.
- Liberation Day: Recent tariff announcements are unlikely to clarify or mitigate economic uncertainty, as they appear to be part of ongoing bilateral trade negotiations. The Trump administration has acknowledged that their aggressive policy actions are likely to create near term pain.
- Labor Market Signal: Despite concerns about government related job losses extending into the private sector, initial unemployment claims remain low and stable. A solid job market is very important to sustaining consumer spending, so we are watching the labor market closely.
- Stagflation: The combination of slowing growth, rising unemployment, and increasing inflation defines stagflation, a rare but challenging economic condition to manage with conventional policy tools. We anticipate that concerns about stagflation will intensify under the current conditions.
- Remain Calm: We remain in the soft-landing camp because businesses are still financially strong. Corporate balance sheets are strong, and profit margins remain high. Consumers are also generally in good shape given low unemployment, good real wage growth and low debt burdens.
- Higher Quality: We tactically increased our investment grade bond exposure, shifting to a slight overweight, to mitigate overall risk in our models. High quality fixed income presents an appealing risk-adjusted return potential, characterized by attractive yields and lower economic sensitivity.
- Duration Neutral: We adjusted to a neutral duration stance, as we believe interest rate risks are now more balanced. The prospect for slower growth could put downside pressure on yields, while sticky inflation and ongoing government budget negotiations could drive yields higher.
- Continuing Resolution: Congress passed a bill to continue spending at current levels through September, averting a government shutdown. The temporary measure provides a brief window to negotiate a deal which may include significant cuts to entitlements coupled with an extension of the 2017 tax cuts. We anticipate reliance on accounting maneuvers and optimistic economic forecasts to project fiscal prudence, though we expect the Treasury market to see through such strategies.
- Unsustainable Debt: The nonpartisan Congressional Budget Office has updated its long-term budget outlook, forecasting significant, ongoing deficits that elevate the country’s debt-to-GDP ratio to historic levels by 2029. The projections assume the expiration of the TCJA tax cuts. The outlook underscores an unsustainable debt trajectory, increasing pressure on Congress to enact a more balanced budget.
- Monetary Policy Pause: The Fed is on hold, forecasting lower economic growth and higher core inflation by year end. The committee did agree to slow the pace of reduction of Treasury holdings on their balance sheet which may help support Treasury yields in the near term. We believe the Fed remains in easing mode but may not be ready to adjust rates again until they have more clarity on the economic impact of the administration’s trade policies.
- Yield Cushion: The relative return potential for high quality, intermediate maturity fixed income has improved, supported by attractive starting yields. Should economic risk intensify we would expect the asset class to provide valuable diversification.
- Cautious on Credit: We reduced our exposure to non-investment grade bonds, shifting to a slight underweight from a slight overweight to trim pro-cyclical risk.
- Spreads Resilient: Despite adverse economic news and negative sentiment, spreads across corporate and securitized credit have widened only marginally. Spreads in both investment grade and high yield corporate sectors remain below the peaks observed last summer. Similarly, investment-grade securitized credit spreads have remained stable since the beginning of the year.
- What to Watch: There is potential for further widening of spreads amidst this period of policy uncertainty. With the onset of the earnings reporting season, we will closely monitor any shifts in corporate spending plans, increases in layoff announcements, and changes in forward earnings guidance.
- Strategic Allocation: We continue to endorse the inclusion of high yield debt within diversified portfolios that encompass stocks and bonds, aiming to enhance the return potential of fixed income while providing downside protection relative to equities.
- Stay Nimble: As businesses remain financially strong, we expect any improvement in relative value may tempt investors, armed with plenty of dry powder, back into the credit markets at spread levels narrower than in previous cycles.
- Active Management Required: The present market conditions are expected to distinctly separate winners from losers, offering opportunities to generate returns and manage risks effectively. We remain committed to adapting our tactical credit allocations in response to evolving market dynamics.
Fixed Income Indexes Characteristics
The Indexes mentioned are unmanaged statistical composites of stock market or bond market performance. Investing in an index is not possible.
For Index Definitions see: TouchstoneInvestments.com/insights/investment-terms-and-index-definitions
2022 – The Fed embarked on one of its most aggressive tightening paths seen in decades as the inflation rate surged well above their goal. Interest rates rose across all maturities leading to one of the worst years for fixed income returns.
2023 – Inflation fell broadly while the economy grew with the labor market and consumer spending resilient. The Fed paused midyear helping rates and credit spreads fall late in the year and turning returns positive for the year.
2024 – Economic growth continued unabated, driven by consumer spending. Inflation moderated further. The Federal Reserve pause continued until September, after which it cut interest rates three times by a total of 1 percentage point. Bond yields rose in response, resulting in only modest gains for high quality fixed income but better returns for riskier areas of fixed income.
The Touchstone Asset Allocation Committee
The Touchstone Asset Allocation Committee (TAAC) consisting of Crit Thomas, CFA, CAIA – Global Market Strategist, Erik M. Aarts, CIMA – Vice President and Senior Fixed Income Strategist, and Brian Cheyne, CFA, CIMA – Senior Investment Strategy Specialist, develops in-depth asset allocation guidance using established and evolving methodologies, inputs and analysis and communicates its methods, findings and guidance to stakeholders. TAAC uses different approaches in its development of Strategic Allocation and Tactical Allocation that are designed to add value for financial professionals and their clients. TAAC meets regularly to assess market conditions and conducts deep dive analyses on specific asset classes which are delivered via the Asset Allocation Summary document. Please contact your Touchstone representative or call 800.638.8194 for more information.
A Word About Risk
Investing in fixed-income securities which can experience reduced liquidity during certain market events, lose their value as interest rates rise and are subject to credit risk which is the risk of deterioration in the financial condition of an issuer and/or general economic conditions that can cause the issuer to not make timely payments of principal and interest also causing the securities to decline in value and an investor can lose principal. When interest rates rise, the price of debt securities generally falls. Longer term securities are generally more volatile. Investment grade debt securities which may be downgraded by a Nationally Recognized Statistical Rating Organization (NRSRO) to below
investment grade status. U.S. government agency securities which are neither issued nor guaranteed by the U.S. Treasury and are not guaranteed against price movements due to changing interest rates. Mortgage-backed securities and asset-backed securities are subject to the risks of prepayment, defaults, changing interest rates and at times, the financial condition of the issuer. Foreign securities carry the associated risks of economic and political instability, market liquidity, currency volatility and accounting standards that differ from those of U.S. markets and may offer less protection to investors. Emerging markets securities which are more likely to experience turmoil or rapid changes in market or economic conditions than developed countries.
Performance data quoted represents past performance, which is no guarantee of future results. The investment return and principal value of an investment in the Fund will fluctuate so that an investor’s shares, when redeemed, may be worth more or less than their original cost. Current performance may be higher or lower than performance data given. For performance information current to the most recent month-end, visit TouchstoneInvestments.com/mutual-funds.
Please consider the investment objectives, risks, charges and expenses of the fund carefully before investing. The prospectus and the summary prospectus contain this and other information about the Fund. To obtain a prospectus or a summary prospectus, contact your financial professional or download and/or request one on the resources section or call Touchstone at 800-638-8194. Please read the prospectus and/or summary prospectus carefully before investing.
Touchstone Funds are distributed by Touchstone Securities, Inc.*
*A registered broker-dealer and member FINRA/SIPC.
Touchstone is a member of Western & Southern Financial Group
Not FDIC Insured | No Bank Guarantee | May Lose Value
