by Bryan Perry

November 7, 2023

It’s rare that the Street gets excited about bonds, but after last week’s wink and nod from Jerome Powell that the “pause” on rates might also mean the Fed is done for this cycle, all classes of bonds ripped higher in reaction. Calls from trading desks around the world to “lock in rates” were resonating all of last week.

The combination of last Monday’s Treasury issuance of the less-than-forecast $776 billion for the current quarter, followed by the schedule of shorter maturities that would meet better demand, followed by a dovish Fed policy statement, topped off by Friday’s weaker employment data, provided even more fuel.

The yield on the 2-year Treasury moved from 5.08% on Monday to 4.84% at Friday’s close – a 24 basis point move. In a more dramatic move, the 10-year T-Note yield fell from 5.00% to 4.48%, before settling at 4.55% for the week – a 45 basis point drop, one of the more dramatic Treasury yield moves in recent memory, providing momentum into the weekend that was certainly the main catalyst for the stock rally.

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

The bond market is the default mechanism for investors who care about preservation of capital as their #1 priority. However, with U.S. fiscal policy in the “drunken sailor” school of economics, it stands to reason that yields on the long end of the curve will remain elevated due to long-term risks associated with a soaring federal budget deficit. In my view, that ship is on its own course, and with no political will to rein in spending, it doesn’t look good to place your bets on America’s fiscal future going out 20-30 years.

With China and Japan dumping U.S. Treasuries, and the U.S. Treasury now issuing trillions of dollars in fresh paper, the pressure on maturities of 10 years or further out could remain under suspicion, whereas the short-end of the curve starts to anticipate rate cuts by the Fed beginning in mid-2024, at the latest.

As of last Friday, the CME FedWatch Tool shows a nearly 50% chance of a quarter-point rate cut at the May 2024 FOMC meeting. If the softer jobs data begins a trend of weaker labor numbers going forward, then this forecast looks pretty good, and investors should want to be in front of this by a good six months.

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

Buttressing the CME FedWatch Tool forecast is the sharp decline in fourth-quarter GDP estimate by the Atlanta Fed’s GDPNow estimate, showing the U.S economy growing at just a 1.2% rate, down from 4.9% last quarter. Some economists are even calling for negative growth. This report raised a lot of eyebrows across the investment community last week, as it implies a fairly dramatic slowdown in consumer spending for the holiday shopping season, coupled with lower business investment by year’s end.

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

With these parameters as a backdrop, buying investment-grade corporate bonds with maturities of 2-to-4 years looks to be an attractive investment proposition for a number of reasons.

  1. If the Fed is going to start cutting rates by the middle of next year, rolling six-months to one-year Treasuries will be done so at lower rates than where they trade today – which is probably why billionaire hedge fund manager Stanley Druckemiller bought a huge position of 2-year Treasuries, expecting the yield curve to normalize with the 2-year rate dropping to 3% in a couple years.
  2. While a laddered 2, 3 and 5-year Treasury portfolio is paying a blended yield of 4.66%, a laddered 2, 3, and 4-year investment grade corporate bond portfolio is paying 5.83%, a full 117 basis points higher, but with one caveat. Treasuries are issued at par every week, so investors are receiving the full average 4.6% interest income. Most corporate bonds in the 2-4-year range are trading at discounts to par since they were issued when rates were lower. Hence, the average distribution rate is about 3.8%, but the yield to maturity (total return) is around 5.83% as there could be capital appreciation, too.
  3. If in fact Washington can’t agree on debt reduction, then the risk of a government shutdown and failed bond auctions rises. If there is another regional banking crisis due to holding too many low-yielding Treasuries, too much corporate office debt, too much money leaving for higher money market yields, then CDs are at risk of being “money good” when they mature. Get in line at the FDIC.
  4. Conversely, with high-grade corporate debt now pushing 6% on a total return basis for 2-4 years, why not have money on deposit in the best-fortressed balance sheet companies in the world?

Bonds in the top blue-chip S&P 500 companies cannot be easily purchased by individual investors. Institutional money gobbles them up the instant they become available, but there are some ETFs that provide for buying baskets of these bonds that pay monthly. While there is no guarantee the bond yields might not rise further, at least the risk of short duration for maturities is well defined, and something close to 6% for 24-48-month corporate debt that is as near to bullet proof, just might make perfect sense.

All content above represents the opinion of Bryan Perry of Navellier & Associates, Inc.

Please see important disclosures below.

About The Author

Bryan Perry

Bryan Perry

Bryan Perry is a Senior Director with Navellier Private Client Group, advising and facilitating high net worth investors in the pursuit of their financial goals.

Bryan’s financial services career spanning the past three decades includes over 20 years of wealth management experience with Wall Street firms that include Bear Stearns, Lehman Brothers and Paine Webber, working with both retail and institutional clients. Bryan earned a B.A. in Political Science from Virginia Polytechnic Institute & State University and currently holds a Series 65 license. All content of “Income Mail” represents the opinion of Bryan Perry

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