by Bryan Perry

September 29, 2020

Treasury bond yields have spent most of September unchanged to mildly lower as market volatility has surged higher. The two are highly correlated but considering the -10.6% decline in the S&P 500 and a -12.9% slide in the Nasdaq Composite over a three-week period, one would assume yields of government-backed debt would have rallied more. Below is a chart of the U.S. Treasury market for September.

United States Treasury Market Table

The low for the S&P and Nasdaq came last Thursday when the S&P touched 3,210 before snapping back to close the week at 3,298, but bond yields didn’t budge as it appeared the market was taking a “risk off” tone in what was considered a highly oversold condition – but a two-day rally does not define a trend.

Congress is going to try to pass another stimulus package somewhere in the $1.5-$2.2 trillion range and the Fed has promised to keep priming the QE pump and is encouraging Congress to act swiftly to add needed fuel to the recovery. As is stands, the Fed’s balance sheet is over $7 trillion – highest of all time.

This double-barreled approach to saving the economy from a long-term downtrend is clear, and as long as interest rates and yields remain near zero, the cost of financing the pandemic bailout is a small concern.

United States Federal Reserve Total Assets Chart

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

Spending will continue to soar – something President Trump and big government proponents on both side of the aisle fully support. “It will be hard to ratchet down this spending going forward, and we are going to be entering a long stretch of deficits well above historical averages,” said G. William Hoagland, a senior vice president at the Bipartisan Policy Center and former Republican staff director for the Senate Budget Committee. “But as a matter of national politics, the deficit was not a matter of concern before the pandemic and it won’t be after.”

The Fed’s latest policy statement was centered on doubling the rate of inflation to average 2% so as to get wages up and boost consumer buying power, but the Fed has a mixed record of actually being able to control prices. Fed Chair Powell acknowledged this in his latest press conference, implying that Congress will need to do more to fuel a full recovery, where the rate of unemployment falls back below 5%.

So, if current Fed policies are to remain in place indefinitely and Congress is expected to do their part in replacing any lost GDP with stimulus packages, then the trajectory of the national debt begins to steepen radically in 2023 if the models put forth by the Congressional Budget Office are anywhere near accurate.

Debt Held by the Public Chart

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

Assuming the efforts of the Fed to raise inflation in conjunction with Congressional spending are realized in the next two years, it’s hard to imagine the cost of living coming down when wages are increasing.

“Voodoo Fed Policy”?

The phrase “voodoo economics,” first used by George Bush Sr. in criticizing Ronald Reagan’s economic policies, became a popular, widely-used phrase to dismiss ambitious economic pledges made by politicians, but I would venture to say that the Fed wanting to double the rate of inflation without seeing yields rise as a byproduct of inflationary forces falls into the category of “voodoo Fed policy.” Soaring debt loads, a falling dollar, and higher inflation will invariably lead to higher bond yields down the road.

The European Central Bank is also working off the same template. The ECB aims at inflation rates of below 2% over the medium term. In spite of the euro’s strength, the ECB’s inflation forecast for 2020 remains unchanged at 0.3% but has been revised up to 1% next year and then reaches 1.3% in 2022.

Again, central bank forecasting and reality tend to be wide apart. Inflation in the eurozone sank to a negative annual rate of -0.2% in August, with “core” inflation (stripping out prices of food and energy) at a historical low of 0.4%. With the ECB lending rate at a negative -0.5%, there is no room to take rates lower, which means we should look for a resumption of increased fiscal stimulus.

Now, what should income-hungry investors do if they seek the security of the investment grade bond market without taking on the risk of yields making a surprise move higher due to currency devaluation associated with this unimaginable amount of government debt?

Well, one asset class to consider at this juncture is floating rate investment grade corporate assets tied to the Fed Funds Rate or the 3-month London Inter-bank Offered Rate (LIBOR). The current Fed Funds Rate is 0.25% and the 3-Month Libor Rate is 0.22%. Can they adjust further lower? Sure, but the risk is probably 0.25%-0.50% versus whatever number you want to apply to the upside for yields.

United States Fed Funds Rate Chart

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

The opportunities to invest in floating rate securities are many and varied. For those seeking fortress-type security, floating rate investment grade bonds that are bought individually, the best bets are the ETFs loaded with these floating rate bonds, They were hit hard back in March as money flew out of everything.

These ETFs tend to be heavily weighted in financials – hence the related volatility. When market corrections come, bank stocks and related holdings get whacked hard and thus are not safe from big market downdrafts. Issuers in economically defensive businesses make more sense.

Here is a smattering of current issues traded:

1.38% Verizon Communications Inc. Notes due 5/15/2025 BBB+
1.43% AT&T Inc. Notes due 6/12/2024 BBB
0.64% Florida Power & Light Co. due 7/28/2023 A
1.26% Vodaphone Group Plc due 1/16/2024 BBB
1.25% General Electric Co. due 3/15/2023 BBB+
1.00% Qualcomm Inc. due 1/30/2023 A-
0.91% Comcast Corp. due 4/15/2024 A-
0.75% United Parcel Service due 4/1/2023 A-
0.74% Apple Inc. due 2/9/2022 AA+
0.60% Intel Corp. due 5/11/2022 A+
0.90% Abbvie Inc. due 11/21/2022 BBB

Granted, the yields are low, but the credits are investment grade, the maturities are short-term and liquid. While there are plenty of other high-grade bonds to buy with short maturities that yield more, there is no protection against inflation.

My point is not to recommend these types of bonds in the current low rate environment that could persist for quite some time, but to simply introduce a class of security to investors who are very risk adverse and want the surety of investment grade bonds, and to be able to benefit if and when interest rates rise.

If for any reasons, or number of reasons, Fed Funds and LIBOR start moving higher, individual short-term inflation indexed bonds will be a go-to instrument that will deliver safety and rising income.

That’s something to think about when the Fed eventually tightens.

Navellier & Associates does own Verizon Communications Inc., AT&T Inc, United Parcel Service, Apple Inc., Intel Corp. and Abbvie managed accounts but does not hold Vodaphone Group Plc General Electric Co. Qualcomm Inc. or Comcast Corp.  Bryan Perry does not own Verizon Communications Inc., AT&T Inc. Florida Power & Light Co., Vodaphone Group Plc, General Electric Co., Qualcomm Inc., Comcast Corp., United Parcel Service, Apple Inc., Intel Corp., or Abbvie Inc. personally.

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

Please see important disclosures below.

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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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