(New York)
While there are a lot of concerns about the bond market right now, one of the risks that is being ignored is credit quality itself. Well, there might be a bomb set to go off in credit. In particular, there appear to be major risks in the Triple BBB category of bonds. This group is considered investment grade, but only just so. There are currently $2.5 tn in US debt with this rating, double the level of five years ago, according to Morgan Stanley. MS says that in a downturn, investors may abandon this type of debt, raising rates for the borrowers, and in turn exacerbating the economic contraction. All of which seems likely to hurt the stock market.
FINSUM: This part of the bond market is so huge, that an exodus from this area would greatly wound the economy.
(New York)
The bond market is in flux. It is caught between several strong opposing forces. On the one hand, the Fed looks intent to raise rates. On the other, many are worried about a recession. Finally, the huge and increasing crop of retirees need reliable income. With that in mind, here are some potentially good bond buys from Pimco. The fund manager doesn’t think we will have a recession soon, saying “We think the [economic] cycle will continue for the next couple of years, but stocks aren’t cheap and bonds aren’t cheap”. Pimco suggests looking at high quality junk bonds, and the short end of the Treasury yield curve (e.g. 2-years, which are yielding over 2%).
FINSUM: High quality junk is still yielding over 5%, while the short-end of Treasuries also looks appealing. We don’t think there is a reason to flood out of bonds yet.
(New York)
One of the most popular fixed income assets for wealthy US investors are municipal bonds. Their tax exempt status has made them continually popular, but what will their fate be during a period of rising rates? There are currently fears that tax cuts and rising rates will wound the sector, but one top financial advisor says the muni sector “will retain its rightful position as a place where wealthy Americans protect their wealth”. Despite rising rates there will be lower issuance this year, which will protect the sector. Additionally, tax cuts for the wealthy will be modest, and not really enough to damage munis. “They will still be a relative value compared with other fixed-income, high-grade asset classes”.
FINSUM: We suspect munis will continue to have a high degree of demand, and if issuance stays low, then those are two important supportive factors. However, some municipalities are facing big budget and pension issues, which could pose a risk.
(New York)
All the biggest names in bonds—Gross, Gundlach, Dalio—have been warning that a major bond bear market is on the way. However, Bloomberg is arguing that bears may have to wait as the tide in the bond market is reversing. Treasury yields’ rise has stalled, and in certain parts of the world (e.g. Germany), yields are once again falling. The big reason why is global fears over a possible trade war which could sink the economy broadly. This would weaken inflation and hamper hikes by central banks, pinning rates.
FINSUM: We have repeatedly said that we do not think there will be a bond bear market. There is a lot of natural demand for bonds given the aging population, which should keep yields at bay even if other forces are causing them to rise.
(New York)
One way to judge the fear level of investors in regards to inflation is to look at flows into TIPS, or Treasury Inflation-Protected Securities. The bond market had its biggest bout of volatility in around a decade over the last 6 weeks, and one big upshot of that has been a surge into TIPS, as investors seek a safe haven for the strong rise in inflation which they see coming. BlackRock’s TIPS ETF, for instance, just hit a new high with $25 bn under management.
FINSUM: Interest in TIPS has a lot to do with the Fed and rates, but also with the government’s budget deficit, which is set to widen.
(New York)
One of the biggest surprises in the rise of ETFs has been the dominance of stocks over bonds. Bonds have always had some liquidity challenges for individual investors, so at the outset one would have expected bond ETFs to do well since they greatly enhanced accessibility to the asset class. However, while stock ETFs have exploded, bond ETFs have been more of a steady progression, but things are heating up. Bonds represent 15% of the total ETF market, but are growing quickly, with the market size doubling to $1.5 tn by 2022.
FINSUM: We think bond ETF demand will rise in line with rates. Once people start seeing 5% yields plus on solid bonds with short durations we think there will be more and more buying.
(New York)
PIMCO, perhaps the most famous bond investor in the world, has just published a piece covering their view of where yields are headed. Their conclusion is that they do see the risk for rates rising as the US budget deficit grows and the economy strengthens, but that on the whole they are not too concerned about a big jump. Their view is best summarized in their own words, “Nevertheless, we believe powerful forces are working against a permanent increase in the trajectory of economic growth in the U.S., including the aging population, productivity trends, sovereign indebtedness, credit growth, and an imbalance between savings and investments”.
FINSUM: Our readers will have noticed that this view exactly matches what we have been saying about bond yields.
(New York)
Despite a seemingly very hawkish Fed, bond traders just aren’t buying it, according to Bloomberg. Traders think the economy is burning very hot, and that the Fed, despite rhetoric, is actually content to just stick to only gradual rate hikes. According to one CIO, “The bond market is telling the Fed we see rising inflation pressures and if you are going to be gradual and crawl into three more rate hikes this year we are not going to wait around”, continuing “The long end of the yield curve is tightening for the Fed”.
FINSUM: Fed minutes did not show that the bank was considering four hikes this year, and the market thinks they should be.
(New York)
Many investors are currently worried about the bond market. There is a lot of uncertainty over just how much rates and yields will rise and what that might mean for the economy. Well, Bloomberg is taking a strong stand on the issue, arguing that a bond Armageddon is on the way. The paper says that all the focus has been on ten-years, but that 30s might be where the danger is. They are within shouting distance of their 2015-2017 highs, and are very close to the 3.24% level, which would signal the difference between an orderly selloff and a full-on rout.
FINSUM: There may be some short-term volatility, but our overall view is that there won’t be a cataclysm in bonds. Global populations are aging and people need income. We expected yields to stay in check and spreads to narrow even if sovereign yields rise.
(New York)
In an article that contrasts strongly to some others we are running today, here is a different view on bonds coming out of the Wall Street Journal—that the bull market is far from over. The argument is based on two interconnected factors. The first is that rates and yields do look likely to rise in the short term, but at the same time, there are many signs the business cycle is poised to end, which will bring on a recession. When that happens, yields will once again plunge, keeping the bond market surging.
FINSUM: If a recession does come then rates and yields will likely drop again. Unless of course inflation sticks around and we get caught in a stagflationary period.
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(Washington)
Whether one likes it or not, Treasury yields hitting 3%, which they look bound to do, will be a major event. The big question is what to do once it happens. Is it the signal of a sharp move higher in yields, or will it be the climax to a short-lived selloff? The reality is that if Treasuries move just a little above three, there could be a strong wave of selling. However, strategies betting against volatility have been paired back in recent weeks, so the selling might not be as furious as one might fear.
FINSUM: Nobody has any idea what will happen if Treasuries move above 3%. As far as bonds, we expect that there will be more and more organic buyers above 3%, which should keep things in check. On the stock side, we do not see why a move higher would be too bad, as the spread to equity yields will still be wide.
(New York)
Here is a tough question to judge—are Treasury bonds yielding 3% good news or bad for the markets? Investors themselves haven’t made up their minds. At first the prospect of rising yields spooked investors, but they have recently grown much more tolerant. While at first investors were shy about rising rates ending the recovery, higher yields now seem to be interpreted as a sign that we have finally overcome worries about “secular stagnation” in the economy.
FINSUM: Our own view is that rates rising back to “normal” is a sign of the economy doing well, and thus is nothing to fear for equity investors.
(New York)
The market did something that seems quite odd yesterday. Despite inflation coming out ahead of expectations and Treasury bonds commensurately selling off, stocks rose strongly. It was the first time the two asset classes had moved in significantly opposite directions in some time. Yields on the ten-year bond extended their four-year high to 2.92%, seven basis points higher than in the previous session.
FINSUM: We have been saying for the last couple of weeks that investors would realize inflation wasn’t necessarily bad for stocks. The market seems to have woken up to that reality.
(New York)
Goldman Sachs put out a big warning to the market yesterday. The bank’s fixed income division says that it thinks yields on ten-year Treasuries are going to rise to 3.5% within two quarters as the Fed continues to hikes rates and the market sells off. Goldman called its prediction “not very brave”, indicating it thinks yields might be higher, especially since it feels the Fed will hike four times this year. Goldman’s forecast for rates is much higher than most analysts, so if it comes to pass, it could have big ramifications for equity investors.
FINSUM: If yields rose to 3.5% or above that quickly, we expect the equity markets would perform very poorly, and it may be the kind of scenario where we have a recession.