(New York)
Individual bond sales to retail clients may be about to take a hit. The reason why is a new set of rules being enacted on brokers that require them to disclose the price at which they bought bonds before they sell them to clients (if it occurs on the same day). The idea of the rule is to give investors a clear idea of the price they are paying for bonds. Brokers are worried that the new rule will cut into their fees and lead investors to stop buying bonds in favor of bond funds.
FINSUM: So we understand the thrust of this rule, but as a counterargument, we ask our readers to consider: what other industries have to disclose their margins to customers during a transaction? When you buy a new iPhone, does apple need to say they have a 90% margin on the phone?
(New York)
There has been a lot of fear about bonds lately. Higher inflation readings, a more hawkish Fed, and 3% Treasury yields have gotten investors nervous. However, bonds might be in for some big gains, especially Treasuries. The reason why is that there is a huge pile of short positons held by hedge funds who are betting against Treasuries. Yet, yields have been stubborn over the last couple of weeks and now it appears the positon might be broken by a strong short squeeze that would send prices higher.
FINSUM: We had not paid much attention to this, but given the weak US inflation reading that has just been released, this may play out very soon.
(New York)
The market has become very fixated on higher rates and yields, with every investor nervous it will cause losses in their stock and bond portfolios. However, one Wall Streeter is saying fears are overblown, especially as it concerns how stocks lose on account of bonds. The logic is that stock P/E ratios never fully took account of ultra-low yields, so in effect, there is a cushion in stock prices against rising yields. Therefore, yields crossing 3% won’t necessarily cause any losses.
FINSUM: This is the “priced-in” logic of stock prices. We must say we do not agree. This kind of argument assumes that investors are being rational and have long memories, as well being agnostic of short-term changes in priority. We do not think the market is this impervious to fear.
(New York)
It has been many years that analysts have been talking about how and whether technology would disrupt bond trading the way it did stocks. However, until very recently, and aside from ETFs, the market had remained very steady, with voice trading and human connections driving the market. An example of the changes can be seen at fund manager AllianceBernstein, where 35% of all fixed income trades are conducted by an in-house algorithm rather than people. Automation of government bond trading is happening rapidly, as liquidity and standardization is quite high, but some are skeptical technology will ever come to change other areas of fixed income such as corporate debt, municipals etc.
FINSUM: There are simply too many idiosyncrasies (e.g. terms) and too many different bonds to have enough liquidity for electronic trading in corporate and other debt markets. That said, sovereign debt seems likely to be completely dominated by automated trading.
(New York)
Something very interesting is going on in the junk bond market—things are good. The market for risky corporate debt has seen a resurgence over the last couple of months, and even as benchmark yields have risen, returns for junk bonds have been positive. The spread between high yield and benchmark Treasuries has shrunk from 369 basis points to just 333 basis points since February 9th.
FINSUM: This is a very important move as it it is a positive sign about the business cycle. Junk bonds and other credits have often been leading indicators, and the fact that investors are still showing faith in them is very positive.
(New York)
Barron’s has just put out a strong warning telling investors that they should stay away from long-term bonds. If you step back from the day-to-day movements, the picture is clearly that yields are moving higher. For instance, they started April at 2.7% and are now at 3% for the ten-year. The longer the bond, the more its value is affected by yield movements, a concept called “duration risk”. Therefore, when markets are this volatile, it is best to stick to the short end of the curve.
FINSUM: Most advisors will know that investors have been pouring money into short-term bonds, probably because they seem like a great buy. For instance, two-year Treasuries are yielding around 2.5%.
(New York)
Ten-year Treasuries are currently hovering around the 3% yield mark. This has alarmed some investors, but the market seems to be more bullish following yesterday’s moves. Now, with the move higher in yields stalling, Citigroup is calling for a huge rally in the notes, saying they will return to 2.65% yields. According to the bank’s strategists, “Equity markets are reacting negatively to increases in Treasury yields … A further sell off in rates will be held in check by the feedback loop from equity markets”.
FINSUM: A rally is possible, but Citi is saying this will occur because of a sell-off in stocks sparked by fears over inflation and rates. Not as bullish as it sounds.
(New York)
Alongside the rise in bond yields, investors have been pouring money into short-term bonds, says Barron’s. With rates and yields rising, short-term bonds have less rate risk. But even more, their yields look very attractive versus long-term bonds. Two-year treasury yields are now over 2.5%, versus just 3% on a ten-year note.
FINSUM: Why wouldn’t one be putting money in short-term bonds right now? They are relatively insensitive to rate hikes and are offering solid above-inflation yields.
(New York)
If anything is becoming clearer in financial markets, especially after yesterday, it is that rates and yields are bound to rise. Thus many might be worried about how to protect their clients from the changing market. Barron’s has some suggestions. The key is to hold a fixed income portfolio for several years, a minimum of six, and to make sure to reinvest proceeds in higher yielding bonds. To achieve the targeted five-year maturity sweet spot, consider Vanguard’s intermediate Treasury fund, while also mixing in some Treasury Inflation Protected Securities (TIPS) to provide further protection.
FINSUM: This seems like a good strategy for a long period of gradual rate hikes.
(New York)
As we have told readers, we have been keeping our antennae up for signs that an economic downturn may be on its way. Well, the biggest one of all just showed its head, and investors need to take notice. An important part of the rates market just showed an inverted yield curve. The one-month U.S. overnight indexed swap rate is now inverted, and this implies some expectation of a lower Fed policy rate after the first quarter of 2020, says JP Morgan. The Bank summarizes the situation this way, saying “An inversion at the front end of the U.S. curve is a significant market development, not least because it occurs rather rarely … It is also generally perceived as a bad omen for risky markets”.
FINSUM: If the market thinks rates are going to be lower in 2020, that means parts of the bond market are expecting a recession between now and then. Take notice.
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(New York)
The US credit market has not exploded, but as yields drift higher, the situation is worsening. High yield is seeing yields and prices back to where they were in 2016, though not quite as bad as in early 2016, which was the last time there was an equity market correction. There are big worries about the huge ($2.5 tn+) pool of triple B bonds, which look vulnerable. Triple Bs now account for half of the US investment grade market. The good news is that corporate earnings are in good shape, which means credit-worthiness is still strong.
FINSUM: We think fears about the credit market are a little overblown at the moment. Earnings and credit-worthiness are still strong, and there is going to be good demand for decent yields, which should keep things in a band.
(New York)
The bond market is scaring a lot of investors right now. It is caught between the likelihood for higher rates and fears over a recession. With that in mind, we thought our readers would be interested to hear some thoughts from WisdomTree Financial, who has put out their “highest conviction fixed income trade” over the next two years. While shorter term duration bonds look attractive, especially one- to three-month bills, WisdomTree says investors should move into floating rate treasuries instead. The US floating rate note (FRN) debuted in 2014 and the rate floats based on the 13-week t-bill yield plus a spread. Coupons are paid quarterly.
FINSUM: So shorter duration bonds look attractive because their yields are strong relative to longer maturities and they have less sensitivity to rates. The FRN seems to accomplish the same goal.
(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.