Evening Brief – 03.29.24
Lock In
The bond market has faced challenges in fully rebounding from the Federal Reserve’s aggressive series of interest-rate increases throughout 2022-2023, while certain areas of resilience are evident.
The challenge for bonds remains closely tied to continued uncertainty about when the Federal Reserve will begin cutting interest rates. However, the weakness in many bond sectors has provided an opportunity. “Yields are still attractive,” said Mike Cudzil, Pimco’s fixed-income portfolio manager.
The U.S. Treasury market, on the other hand, is skeptical that a dovish policy regime is underway. The fundamental reason is that recent inflation remains sticky. However, a sluggish U.S. economy is a competing factor that could ultimately prevail and surmount the Fed’s reluctance to aggressively cut rates.
The Fed’s current median long-term projection for the federal funds rate stands at 2.50%. If short-term interest rates are reduced by half from current levels within the next three to five years, bond prices will increase substantially. There isn’t much time to lock in longer-term yields if the Fed is correct regarding this long-term trend.
The most important thing to determine now is how far out on the curve you want to go so that the bond principle would not be overly affected if inflation were to reemerge.
One could argue that the additional 18 to 27 basis points obtained by extending the investment period to 20 or 30 years, respectively, from the current 10-year U.S. Treasury yield of 4.20%, may not be worth it. Simultaneously, if short-term interest rates are projected to reach 2.5%, it is logical to consider examining maturities ranging from 7 to 10 years.
An alternative to long-term U.S. Treasuries, which offer a greater yield, is investing in investment grade corporate bonds through exchange-traded funds (ETFs). The Invesco Bullet-Shares 2033 Corporate Bond ETF (BSCX) offers a 30-day yield of 5.20%, a dividend rate of 5.05%, and a yield-to-maturity of 5.33%. The bond’s effective term is around seven years.
Investing in an unleveraged bond portfolio ETF with a low management fee of only 0.10% could be a wise choice for individuals looking to secure yields before the Federal Reserve begins reducing interest rates, potentially as early as June.