Fixed Income Desk
A Fed funds rate with a lower band of zero and scorching inflation means one thing: the central bank will need to raise rates and reduce their $9 trillion balance sheet. We expect four, 25-basis-point hikes in 2022 and three to four more in 2023, with the FFR settling in between 2-2.25%. The US economy is certainly strong enough to absorb these hikes, considering they will keep rates accommodative. As for the irresponsible $9T balance sheet, we would expect to see that drawn down to the $7 trillion range by 2024. Still outrageous, but better.
See our Monetary Policy page for more information affecting the fixed income asset class.
Members & Clients: Visit our Strategic Income Portfolio page to see our current fixed-income holdings.
Bank Loans
Senior loans and floating-rate funds |
Corporate Bonds
Bonds issued by publicly-traded companies |
Municipal Bonds
General obligation and revenue bonds issued to fund government or municipal projects |
Sovereign Debt & Global Fixed Income
Debt instruments issued by foreign governments and ex-US companies and capital markets |
Treasury Yield Comparisons
Bond Market Drawdown
Ladder of Current Fixed Income Issues and Penn Weighting Guidance*
The higher you climb on the maturity/duration ladder, the more potential risk you could be taking on.
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Longer-Term Issues (Underweight) 22-year US Treasury: 3.887% 20+ year US Treasuries: 3.884% 20-year Munis (AA-rated): 5.415% 10-20 yr Corporates (A-rated): 5.437% 10-20 year Agencies: 4.648% Intermediate-Term Issues (Equal-weight) 7-10 year Municipal Bonds (AA-rated): 4.946% 7-10 year Corporates (AAA-rated): 3.875% 7-10 year Agencies: 4.505% Short-Term Issues (Overweight) 5-year Treasury: 3.858% 3-year US Treasury: 4.129% 1-3 year Corporate bonds (A-rated): 6.108% 1-3 year Agencies: 5.036% 15-mo callable CD: 4.909% 9-mo CD: 4.750% 6-mo CD: 4.750% Money Market Funds: 4.41% |
*Please note: the above are examples for rate comparisons only; there is no guarantee these issues will still be available
2-yr Treasury
yield: 4% 19 Sep 2022 |
The sudden and unusual opportunity in short-term bonds
Every now and again, bizarre things happen in the bond market which provide unique opportunities for investors. When we buy fixed income vehicles, from CDs to Treasuries to corporate bonds, we expect to get a higher yield for taking on the risk of going further out on the time horizon—assuming parity with respect to issuer safety, of course. For example, we expect a 30-year Treasury bond to have a higher yield than a 10-year Treasury note, and that 10-year should be paying more than a 2-year issue. The benchmark spread is the difference between the 10-year and 2-year yield. When the shorter maturity issue has a higher yield than its longer-maturity counterpart, we get a condition known as a yield curve inversion—generally a sign that a recession is on the way. Right now, we have a quite rare situation: the 2-year Treasury carries a yield higher than all of the longer-maturity issues. Since the 2-year is considered a proxy for what the Fed will do next and the 30-year gauges investor sentiment about the economy, all bets are now on rates continuing to rise until the Fed hits a wall and is forced to pivot. Considering money markets are still yielding close to nothing, and bond values have been dropping in investors’ portfolios, now is a golden opportunity to pick up higher-yielding bonds with shorter maturities and low duration (duration measures sensitivity to changes in the interest rate). And this opportunity is not limited to government-issued securities. While the 2-year Treasury is currently yielding just shy of 4%, corporate issuers are forced to offer even higher rates (either through new issues or thanks to discounted prices on current bonds in the secondary market) to compete with the risk-free nature of vehicles backed by the full faith and credit of the US government. It has been hard to get excited about bonds for some time; right now, at least with respect to the lower end of the ladder, that is not the case. Investors should strike before conditions change. We are loading up on low-duration bonds issued by quality companies to take advantage of current conditions. Even bank-issued CDs with maturities of two years are offering rates around 4%. Due to the unique challenges facing Europe and Asia right now, we are sticking primarily to debt issued by domestic firms and financial institutions. |
Looking to bonds to help protect your portfolio from a market downturn? You may want to take a closer look
(23 Mar 2022) We've talked extensively on this subject, but to reiterate: the days of a passive, 60/40 mix of stocks to bonds have passed. Yet another argument for professional money management as opposed to buying a generic mixed basket of Vanguard funds and believing your portfolio is safe. With inflation surging, and with the Fed finally sending in the troops (via rate hikes and a planned balance sheet reduction), the global bond market is in the midst of its largest drawdown on record. How bad is it? The Bloomberg Global Aggregate Index is the benchmark for measuring the universe of fixed income vehicles, to include government, corporate, mortgage-backed, and other debt instruments from both developed and emerging markets. That index is now sitting at a peak-to-trough drawdown of over 11%. In dollar terms, that equates to a loss of over $2.5 trillion. For perspective, during the drawdown brought on by the financial meltdown of 2008-09, the bond market lost roughly $2 trillion of value. With the Fed signaling a total of seven rate hikes this year alone, fixed income investors know full well that they will be able to get a better yield on bonds purchased next year, hence the drop in value of current bond holdings. For further evidence, consider the yield on the 10-year Treasury note, which moves in the opposite direction of bond values. The 10-year now offers a yield of 2.381%, which represents a 57% increase over the 1.514% rate it offered going into 2022. Why wouldn't bond investors keep their money safe and sound in cash until they can get an even better rate? This in spite of the fact that their cash bucket has a current real yield (i.e., adjusted for inflation) of around -7.5%. It's tough being a conservative investor right now. When selecting fixed income vehicles for our clients, the first metric we look at is duration—a representation of how sensitive the instrument is to changes in interest rates. The lower the duration, the less the vehicle will be affected by rising rates. Right now, we prefer fixed income investments with a duration of five or less. For example, one of our strongest recommendations right now is the SPDR Blackstone Senior Loan ETF (SRLN $45), which has a yield of 4.55% and a tiny duration of 0.301.
(23 Mar 2022) We've talked extensively on this subject, but to reiterate: the days of a passive, 60/40 mix of stocks to bonds have passed. Yet another argument for professional money management as opposed to buying a generic mixed basket of Vanguard funds and believing your portfolio is safe. With inflation surging, and with the Fed finally sending in the troops (via rate hikes and a planned balance sheet reduction), the global bond market is in the midst of its largest drawdown on record. How bad is it? The Bloomberg Global Aggregate Index is the benchmark for measuring the universe of fixed income vehicles, to include government, corporate, mortgage-backed, and other debt instruments from both developed and emerging markets. That index is now sitting at a peak-to-trough drawdown of over 11%. In dollar terms, that equates to a loss of over $2.5 trillion. For perspective, during the drawdown brought on by the financial meltdown of 2008-09, the bond market lost roughly $2 trillion of value. With the Fed signaling a total of seven rate hikes this year alone, fixed income investors know full well that they will be able to get a better yield on bonds purchased next year, hence the drop in value of current bond holdings. For further evidence, consider the yield on the 10-year Treasury note, which moves in the opposite direction of bond values. The 10-year now offers a yield of 2.381%, which represents a 57% increase over the 1.514% rate it offered going into 2022. Why wouldn't bond investors keep their money safe and sound in cash until they can get an even better rate? This in spite of the fact that their cash bucket has a current real yield (i.e., adjusted for inflation) of around -7.5%. It's tough being a conservative investor right now. When selecting fixed income vehicles for our clients, the first metric we look at is duration—a representation of how sensitive the instrument is to changes in interest rates. The lower the duration, the less the vehicle will be affected by rising rates. Right now, we prefer fixed income investments with a duration of five or less. For example, one of our strongest recommendations right now is the SPDR Blackstone Senior Loan ETF (SRLN $45), which has a yield of 4.55% and a tiny duration of 0.301.
A disturbing look into the world of fixed income during the downturn. (Mar, 2020) A lot of wretched things occur to investments during market downturns, but there has always been one stabilizing truth: As equities are plummeting, bonds serve as the beacon in the storm—the one asset class that is most often inversely correlated to stocks. Bond values go up while equity values drop, right? With the global fiscal irresponsibility that has been the norm since the financial meltdown of 2008/09, we can officially throw that paradigm out the window. After three bruising weeks in the market, we took this "golden opportunity" to review eleven popular fixed income holdings. We didn't cherry-pick: they run the gamut of choices, from government bonds to corporates to high yield to emerging markets, and what we found is disturbing—especially considering the Fed lowered rates 50 basis points in the middle of this time-frame, which should have buoyed bond prices. Take a look at the accompanying chart. Two fixed income categories actually underperformed the S&P 500 (the Dow is represented on the graph): high yield bonds and convertible securities. Only two categories were in the green: US Treasuries, as represented by the iShares US Treasury Bond ETF (GOVT), and TIPS (inflation-protected securities). If there is one message to be gleaned from this exercise, it is that old paradigms have been turned on their head thanks to a stew of fiscally irresponsible ingredients. If it is of any comfort at all, at least our money market funds have yet to break the buck. An extended discussion of this topic appeared in the subsequent issue of The Penn Wealth Report.