Doug Drabik discusses fixed income market conditions and offers insight for bond investors.
As recently as one month ago (March 9), the Fed Funds Future implied rate for the upcoming FOMC meeting on March 22 was 4.963% (leaning toward a 50 basis point (bp) hike) and 5.515% for July. Two common inflation measures, Personal Consumption Expenditure (PCE) and Consumer Price Index (CPI) reflected fairly high inflation measures of 6.0% and 4.67% respectively. The 10-year Treasury yield closed on March 9 at 3.90%. On March 10, Silicon Valley Bank was taken over by regulators.
Two extreme options existed. If the Fed hiked rates 50bp, it might exasperate a pending banking crisis fueling potential bank runs (exaggerated deposit withdrawals) and thus unfold a liquidity issue ironically in an environment seemingly flush with cash. If the Fed did nothing, it could be interpreted that they were very worried about a bank run contagion and fuel the panic. On March 22, the Fed split the middle and raised the Fed Funds rate 25bp. The 10-year Treasury closed on March 22 at 3.44%.
PCE was released 10 days ago moving from 4.67% to 4.60%. CPI will be released on Wednesday moving from 6.0% to _?_ (anticipated to be 5.1%). With the intent of fighting inflation, the Fed has raised rates for nine consecutive meetings (since March 2022) totaling +475bp. The 10-year Treasury was 2.15% on the close before the first rate hike. Over the hike cycle, the 10-year yield peaked at 4.24% or 209bp higher than its start and currently is 3.3%. In other words, the 10-year Treasury has mustered up a 109bp change during the period when the Fed has aggressively elevated Fed Funds by 475bp.
Some key observations: The Treasury curve does not move in a parallel manner across maturity ranges. The Fed’s impact on curbing inflation has been methodical with slow moving results. The market has been impulsive and ahead of itself. Key issues persist: cost-of-living concerns, depository institution fragility, inflation tenacity, world food supply crisis, energy supply, etc. It is likely something has to give – or does it? The upper bound Fed Funds rate is 5.0%. The 10-year Treasury is about 3.3%. If the Fed persists in combating inflation by continuing to raise rates, it is possible that the current bond market is indeed ahead of itself and we will get another push up in rates which in turn may bring more undesirable pressure on stocks. If the Fed backs off to support less banking deposit pressure and relax economic strain, the current market enthusiasm may sustain itself. Wednesday’s CPI data might be important in foreshadowing the Fed procedure. Let me state as strongly as I can, that in my opinion, the Fed has been exceptionally transparent for some time now. This Fed committee, in particular the chair, has not hesitated in its proclamation to pull inflation down even if it is at the cost of jobs and economic output.
So what do we know? Fortunately for fixed income investors, the spread product curves, municipal and corporate, remain attractive relative to the Treasury curve. Fixed income buyers may not have the peak in rates to work with, yet there remains high longer-term rates available to benefit investors who can lock in and subsidize with income, their bond’s primary purpose of protecting principal. We are often asked where the value is so I will close with a graph that speaks for itself by highlighting the best income opportunities given any point on the yield curve that fits your particular situation.
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.
Investment products are: not deposits, not FDIC/NCUA insured, not insured by any government agency, not bank guaranteed, subject to risk and may lose value.
To learn more about the risks and rewards of investing in fixed income, access the Financial Industry Regulatory Authority’s website at finra.org/investors/learn-to-invest/types-investments/bonds and the Municipal Securities Rulemaking Board’s (MSRB) Electronic Municipal Market Access System (EMMA) at emma.msrb.org.
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