Preparing for a New Fixed Income Environment in 2024

Aggregate bond benchmarks rebounded this year following some of the worst showings on record in 2022. With heightened expectations that the Federal Reserve could cut interest rates in 2024, fixed income enthusiasm is perking up.

While declining interest rate risk, assuming it materializes, is likely to compel advisors and investors to consider upping their exposure to long duration fare, there are other credible avenues for maintaining robust levels of income even as interest rates decline. That goal can be accomplished in tax-efficient fashion with the help of the NEOS Enhanced Income Aggregate Bond ETF (BNDI).

The actively managed BNDI combines the relative safety of an aggregate bond fund with added income-generating potential because the ETF writes (sells) S&P 500 Index (SPX) options. As a result, BNDI’s income profile is bigger than that of a standard pure beta aggregate bond index fund or ETF.

Betting on Bond ETF BNDI in 2024

Currently, there’s ample enthusiasm for rate cuts in 2024, but investors still need to understand why the Federal Reserve would consider such action. Historically, rate cuts arrive because inflation is declining, in an effort to avert a recession or because economic contraction is already happening.

“Each of these three scenarios leads to an outlook for lower rates and positive returns for bonds. But as another Twain aphorism goes, history may rhyme, but it doesn’t repeat. Post-COVID global economic and financial structural changes suggest the potential for a very different bond market playbook during a cycle of global central bank rate cuts,” according to BlackRock.

Assuming either of the worst case scenarios come to pass, BNDI would still be useful to investors because there’s a chance that elevated equity market volatility derived from macroeconomic concerns would boost premiums on SPX options.

On the other hand, should the Fed lower rates simply because inflation is declining, BNDI would still merit attention by income investors because lower inflation would likely foster elevated risk appetite, potentially compelling investors to take on more duration risk, thus boosting bond prices.

Then again, bond investing could be a conundrum for investors next year and BNDI’s simplicity could prove advantageous in such a scenario.

“We look at the potential for a ‘new’ conundrum—playing out in the opposite way of the ‘old’ Greenspan conundrum from the 2004/2005 hiking cycle. Back then, rate hikes at the short end were not met by rising rates at the long end, prompting the now famous ‘conundrum’ (non) explanation. The impact of structural changes to the global market might similarly argue for longer term rates not falling as much (or even potentially rising) during this cutting cycle,” concluded BlackRock.

For more news, information, and analysis, visit the Tax-Efficient Income Channel.