Quick thoughts from a fixed income strategist
Drew O'Neil discusses fixed income market conditions and offers insight for bond investors.
- CPI (Consumer Price Index) data for September came in higher than market expectations across the board. The headline number came in at 8.2% year-over-year (8.1% was expected). Core month-over-month CPI, which many view as the most important number to the FOMC, was 0.6% (0.4% expected).
- Bloomberg probabilities show that the market is expecting the FOMC to raise the Fed Funds rate by another 75 basis points at their next meeting on November 2nd. That would put the upper bound of their target range at 4.00%. Current estimates are for an additional 75 basis point increase at the final FOMC meeting of the year in December (noting that we are still two months away).
- Treasury yields across the curve are at least 200 basis points higher than at the start of the year, with shorter maturities (5 years and in) higher by at least 300 basis points.
- The Treasury yield is inverted (short yields higher than longer yields) by ~50 basis points when comparing the 2-year and 10-year points of the curve, but the 3-month and 10-year are still positively sloped by ~30 basis points.
- The year-to-date dramatic increases in yields have produced sharp drops in bond prices. This has created an opportunity for many investors to harvest losses for tax purposes where appropriate (consult a tax professional prior to making any trades).
- Yields are at levels not seen in over a decade. Where these yields line up with longer-term goals, this is creating opportunities to lock in yields for a longer amount of time by swapping from shorter maturities into intermediate and long maturing bonds.
- A flat or inverted yield curve does not necessarily dictate that purchasing short maturity bonds is the most attractive option. Remember, yields are an annual number. Hypothetically, assuming a perfectly flat yield curve at 5% (all bonds yield 5%, regardless of the maturity), a 1-year bond will earn you 5% for 1 year but a 10-year bond will earn you 5% every year for the next 10 years.
- Reinvestment risk is the risk that you will have to reinvest cash flow at a lower yield. Shorter maturity bonds return principal to you sooner, exposing you to more near-term reinvestment risk. Longer maturity bonds will extend reinvestment risk further into the future while locking in current yields. A bond ladder will spread out reinvestment risk over a specified timeframe.
- Muni-Treasury ratios are in the neighborhood of their long-term averages, at ~80% at 10-year and ~95% at 30-years. From an after-tax yield perspective, high tax bracket investors will likely benefit from purchasing tax-exempt bonds and lower tax bracket investors will likely be best served in a taxable product.
- BBB-rated corporate spreads are at their highest levels since early 2016 (excluding the COVID spike in 2020) while A-rated spreads are at their highest levels (ex-COVID spike) since 2012. The combination of high benchmark yields and wider spreads puts corporate yields at their highest levels in over a decade across most of the sector.
All data sourced from Bloomberg LP.
The author of this material is a Trader in the Fixed Income Department of Raymond James & Associates (RJA), and is not an Analyst. Any opinions expressed may differ from opinions expressed by other departments of RJA, including our Equity Research Department, and are subject to change without notice. The data and information contained herein was obtained from sources considered to be reliable, but RJA does not guarantee its accuracy and/or completeness. Neither the information nor any opinions expressed constitute a solicitation for the purchase or sale of any security referred to herein. This material may include analysis of sectors, securities and/or derivatives that RJA may have positions, long or short, held proprietarily. RJA or its affiliates may execute transactions which may not be consistent with the report’s conclusions. RJA may also have performed investment banking services for the issuers of such securities. Investors should discuss the risks inherent in bonds with their Raymond James Financial Advisor. Risks include, but are not limited to, changes in interest rates, liquidity, credit quality, volatility, and duration. Past performance is no assurance of future results.
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To learn more about the risks and rewards of investing in fixed income, access the Securities Industry and Financial Markets Association’s Project Invested website and Investor Guides at www.projectinvested.com/category/investor-guides, FINRA’s Investor section of finra.org, and the Municipal Securities Rulemaking Board’s (MSRB) Electronic Municipal Market Access System (EMMA) at emma.msrb.org.