Bonds Get By, with a Little Help from the Fed

Bonds Get By, with a Little Help from the Fed

During WWII, the U.S. government aggressively sold war bonds to individual citizens, urging them to buy bonds to help support the war, and it proved to be a very successful campaign. Today, we are fighting a different kind of “war”, but we are not exactly being enticed by the government to save and buy Treasury bonds. With interest rates at zero and $14 trillion of negative yielding bonds globally, the temptation is to do the opposite. And yet, while government bond yields have declined considerably since the Federal Reserve cut interest rates to zero, yields on non-government bonds have actually moved higher. In the current environment, with interest rates pegged at zero possibly for years to come and a more supportive Fed, certain sectors of the bond market are, in our view, poised to deliver better risk-adjusted returns going forward.

Rather than extending duration to reach for incremental yield, we see more attractive opportunities within corporate credit. While corporate credit has already recovered a lot since markets bottomed in March, continued support from the Federal Reserve and significant liquidity provide strong ongoing tailwinds. Corporate bond yields are higher today relative to where they started the year, and the newest marginal buyer of credit, the Fed, will not be going away anytime soon. In fact, the Fed has the potential to become a very large buyer of credit under new programs. The Fed currently owns just over $10.7 billion of corporate bonds and has the leeway to buy up to $750 billion worth—which represents 42% of investment-grade corporate bonds with maturities of five years or less. 

The outlook for corporate fundamentals continues to evolve. After an increase in downgrades in March and April, the pace has slowed significantly since May with only two downgrades in June. After a very strong second quarter, we believe security selection becomes more important going forward. In our view, as the economy gradually reopens, so too will the corporate bond market generally improve. 

High-yield credit is another area of the bond market that is being supported by the Fed and should continue to benefit as the economy gradually recovers. The average yield of the high-yield index is around 7.6%, a little more than 2% higher than its long-term average and almost 7% higher than what you can earn on a 10-year Treasury bond. Admittedly, investors should prepare to see more defaults this year, but that is priced into the market. The market is currently pricing in a default rate of around 10% while the actual default rate is closer to 5% at present. Fitch is forecasting a 6% default rate this year under its base-case scenario, or as high as 10% in its worst-case scenario.

For taxable investors, municipal bonds offer some of the best relative value—but this is also where much of the headline worries are these days. While all states will face economic pressure, we do not think it will result in large scale downgrades and defaults. Budget shortfalls are likely to result in austerity measures, and states have many policy levers they can pull. The Fed is buying up to $500 billion worth of municipal bonds. The CARES Act provided $150 billion to state and local governments, and more aid is expected to follow. The pandemic’s impact is also likely to be varied, with local governments that rely upon tourism and cyclical revenue streams experiencing more challenges. There is likely to be an uptick in distress across sectors such as long-term care facilities, hotels and convention centers. In contrast, we are more confident about areas of the municipal market with dedicated revenue streams such as utilities, water and sewer bonds. 

In summary, we have seen an overwhelming policy response from the Federal Reserve, which has so far mitigated some of the damage. While U.S. government bonds yields are at all-time lows, our research supports the view that investors can still find relative value by turning to other areas of the bond market. As investors everywhere must adapt to the many various challenges of today, at Sand Hill, we believe that the bond market will get by, with a little help from our friends… at the Fed.


Source: https://markets.jpmorgan.com/#research.rates.us

Articles and Commentary

Information provided in written articles are for informational purposes only and should not be considered investment advice. There is a risk of loss from investments in securities, including the risk of loss of principal. The information contained herein reflects Sand Hill Global Advisors' (“SHGA”) views as of the date of publication. Such views are subject to change at any time without notice due to changes in market or economic conditions and may not necessarily come to pass. SHGA does not provide tax or legal advice. To the extent that any material herein concerns tax or legal matters, such information is not intended to be solely relied upon nor used for the purpose of making tax and/or legal decisions without first seeking independent advice from a tax and/or legal professional. SHGA has obtained the information provided herein from various third party sources believed to be reliable but such information is not guaranteed. Certain links in this site connect to other websites maintained by third parties over whom SHGA has no control. SHGA makes no representations as to the accuracy or any other aspect of information contained in other Web Sites. Any forward looking statements or forecasts are based on assumptions and actual results are expected to vary from any such statements or forecasts. No reliance should be placed on any such statements or forecasts when making any investment decision. SHGA is not responsible for the consequences of any decisions or actions taken as a result of information provided in this presentation and does not warrant or guarantee the accuracy or completeness of this information. No part of this material may be (i) copied, photocopied, or duplicated in any form, by any means, or (ii) redistributed without the prior written consent of SHGA.


Video Presentations

All video presentations discuss certain investment products and/or securities and are being provided for informational purposes only, and should not be considered, and is not, investment, financial planning, tax or legal advice; nor is it a recommendation to buy or sell any securities. Investing in securities involves varying degrees of risk, and there can be no assurance that any specific investment will be profitable or suitable for a particular client’s financial situation or risk tolerance. Past performance is not a guarantee of future returns. Individual performance results will vary. The opinions expressed in the video reflect Sand Hill Global Advisor’s (“SHGA”) or Brenda Vingiello’s (as applicable) views as of the date of the video. Such views are subject to change at any point without notice. Any comments, opinions, or recommendations made by any host or other guest not affiliated with SHGA in this video do not necessarily reflect the views of SHGA, and non-SHGA persons appearing in this video do not fall under the supervisory purview of SHGA. You should not treat any opinion expressed by SHGA or Ms. Vingiello as a specific inducement to make a particular investment or follow a particular strategy, but only as an expression of general opinion. Nothing presented herein is or is intended to constitute investment advice, and no investment decision should be made based solely on any information provided on this video. There is a risk of loss from an investment in securities, including the risk of loss of principal. Neither SHGA nor Ms. Vingiello guarantees any specific outcome or profit. Any forward-looking statements or forecasts contained in the video are based on assumptions and actual results may vary from any such statements or forecasts. SHGA or one of its employees may have a position in the securities discussed and may purchase or sell such securities from time to time. Some of the information in this video has been obtained from third party sources. While SHGA believes such third-party information is reliable, SHGA does not guarantee its accuracy, timeliness or completeness. SHGA encourages you to consult with a professional financial advisor prior to making any investment decision.

Recent Posts

Sep 16, 2021
CNBC Halftime Report: Watching for Catalysts in the Stock Market | September 16, 2021
Sand Hill News
Sand Hill News
CNBC Halftime Report: Watching for Catalysts in the Stock Market | September 16, 2021

On September 16, 2021, Sand Hill CIO Brenda Vingiello, CFA joined the CNBC Halftime Report panel once again and discussed what positive catalysts investors can

read more
Sep 8, 2021
CNBC Squawk Box: What To Expect From Markets in the Coming Months | September 8, 2021
Sand Hill News
Sand Hill News
CNBC Squawk Box: What To Expect From Markets in the Coming Months | September 8, 2021

On September 8th, 2021, Sand Hill CIO Brenda Vingiello, CFA joined the CNBC Squawk Box program once again. Brenda addressed what the month of October

read more
Aug 31, 2021
CNBC Squawk Box: What Could Cause a 5% Market Pullback | August 31, 2021
Sand Hill News
Sand Hill News
CNBC Squawk Box: What Could Cause a 5% Market Pullback | August 31, 2021

On August 31, 2021, Sand Hill CIO Brenda Vingiello, CFA joined the CNBC Squawk Box program once again. In the below clip, Brenda discusses what

read more

Stay up to date, receive email updates from Sand Hill directly to your inbox!