Displaying items by tag: Treasuries
The Case for Increasing Fixed Income Allocation: Goldman Sachs
According to Lindsay Rosner, the managing director of multi-sector fixed income investments at Goldman Sachs, fixed income is presenting investors with an attractive opportunity to lock in high yields without compromising on quality. There are some challenges given divergences in central bank policy around the world and increasing uncertainty about the timing and direction of the Fed’s next move. Overall, the firm believes that the status quo of ‘higher for longer’ is likely to prevail.
A major factor is inflation, and the economy proving to be more resilient than expected. As a result, the market is now expecting two quarter-point rate cuts before the end of the year, compared to expectations of 150 basis points in cuts entering the year. The next Fed decision is on July 29. Prior to that meeting, there will be considerable amounts of inflation and labor market data, which could impact its thinking, although the current expectation is for it to hold rates steady.
With rates at these levels, there is increased risk that consumer spending is affected or that a higher cost of capital begins to impact corporate profitability and hiring. This risk increases the attractiveness of fixed income, especially as many investors are looking to rebalance given strong equity performance. Rosner sees opportunity in higher-quality areas such as investment-grade corporate bonds and structured products with AAA or AA ratings, especially given an impressive carry differential over Treasuries.
Finsum: Goldman Sachs sees opportunity in higher-quality segments of the fixed-income market. It believes investors should lock in yields at these levels, given the risk that high rates will eventually sour the economic outlook.
Robust Economy Threatens Soft Landing: Vanguard
In its Q2 active fixed income commentary, Vanguard discussed lowering rate hike expectations for 2024 due to strong economic data, while inflation remains stubbornly above the Fed’s desired levels.
Despite the odds of a soft landing declining, Vanguard’s base-case scenario is that the Fed is done hiking and will hold rates at these levels until later this year. A risk to the firm’s outlook is inflation lingering above 3%, which would spark discussion about the need for further rate hikes.
It sees monetary policy as remaining data-dependent and notes that the Fed has limited room to maneuver. The central bank risks another surge in inflation by cutting rates too soon, but it also risks a prolonged recession by cutting rates too late.
Despite this uncertainty, Vanguard believes that there will be opportunities amid higher market volatility. It recommends investors take advantage of locking in attractive yields for longer durations and sees potential for better risk-adjusted returns in bonds vs. equities. Over the next 5 years, Vanguard forecasts returns of 4.5% for stocks and 4.3% for bonds. However, bonds are expected to have one-third of the volatility of stocks at 5.2% vs. 15.8%.
Finsum: Vanguard shared its quarterly active fixed income outlook. The firm is downgrading its expectations for rate cuts in 2024, given recent economic data. Instead, it sees more opportunities in other parts of the fixed-income market.
Fixed Income Sector Thriving
2024 has proven to be a year of relentless volatility for fixed income, given mixed signals about inflation, the economy, and monetary policy. However, there are plenty of opportunities to make money amid these conditions.
A consequence of high rates is that the US government is expected to pay more than $1 trillion in interest to bondholders this year, which is more than double the average from the previous decade. Currently, all Treasury securities are yielding more than 4%, and due to elevated rates, investors have a higher margin of safety. This means that fixed income is once again a source of meaningful income for investors and serves as a counterweight to equities.
Deal flow also remains robust, which is a positive for underwriters and sponsors. According to Bloomberg, bankers who underwrite bond offerings are expected to see a 25% increase in bonuses. In terms of sales and trading, bonuses are expected to rise by 20%, compared to an increase of 5% to 15% for equities.
Another trend in fixed income is the electronication of the bond market. Traditionally, bond trading has been done over the phone or through banks, which has resulted in illiquidity and less price discovery.
Now, volume is moving to electronic bond exchanges, which is benefiting market makers like Citadel Securities and Jane Street. These firms are now making markets in government and corporate bonds. It’s estimated that 42% of investment-grade debt trades were electronic last year, compared to 31% in 2021.
Finsum: Entering the year, many were confident that Fed rate cuts would fuel a bull market in bonds. This has failed to materialize, but there have been opportunities in fixed income.
Fixed Income ETF Flows Pick Up in April
April was marked by a mean reversion as robust inflation data and continued economic resilience dampened expectations of Fed dovishness later this year. As a result, flows into equity ETFs dropped from $106 billion in March to $41 billion in April.
In contrast, flows surged into fixed income ETFs, increasing more than 60% to $27.4 billion. Lower-risk government bond ETFs attracted the most inflows at $10.1 billion, which was the highest since October of last year. Within the category, short and intermediate-term Treasuries captured the most inflows.
In the US, flows into fixed-income ETFs were greater than equity ETF flows, at $15.2 billion vs. $14.1 billion. Scott Chronert, the global head of ETF research at Citi, noted “US-listed ETF flows decelerated this month against a generally risk-off backdrop. Underlying trends also pointed to more cautious positioning. Fixed income led all asset classes, but the gains were skewed towards core products, shorter durations, and Treasuries.”
Until something material changes in regard to inflation or the economy, it’s likely that investors will continue to favor ETFs that benefit from short-term rates remaining higher for longer.
Finsum: Fixed income inflows into ETFs sharply increased in April, while equity inflows declined. This was a downstream effect of reduced expectations of Fed rate cuts in the second half of the year due to an uptick in inflation.
Prudential Survey Reveals Insights on Retirement Planning
Prudential conducted a survey of 198 financial advisors to gain insight on how they are investing and constructing portfolios for retirees. 80% use separate portfolios that are specifically designed for retirees. Additionally, the use of targeted portfolios was higher among advisors who were more knowledgeable about planning for retirement.
Another takeaway from the survey is that 50% of retirees prefer to live off of income from their portfolios. Thus, advisors need to ensure that their portfolios generate income for clients while balancing other factors like total return and diversification.
In terms of asset classes for retirement portfolios, advisors favored long-term fixed income, US large-cap stocks, and TIPS. Advisors who were more knowledgeable about retirement planning favored long-term bonds and TIPS to a greater degree than less knowledgeable advisors.
The survey also showed that most advisors are constructing retirement portfolios themselves or with the assistance of third-party recommendations or allocators. Advisors with less knowledge about the subject were more likely to outsource portfolio construction.
Most advisors are helping clients plan for retirement by optimizing for goals such as flexibility in spending or timeframe. This is in contrast to other approaches, which include using a bucket strategy or segmenting the portfolio into different strategies for different purposes.
Finsum: Prudential conducted a survey of financial advisors. Those with more knowledge about retirement planning favored long-term bonds and tend to use differentiated strategies.