Doug Drabik discusses fixed income market conditions and offers insight for bond investors.
You can’t tie everything up in a tightly wrapped package and a pretty bow. How will the second half of the year absorb these first half occurrences and interpretations?
- Economists, analysts, and strategists are often asked to predict the future. This is a daunting task as numerous variables influence the actual path of the economy. Current looming affairs are influential powers capable of changing market direction: Ukraine/Russia war, COVID, inflation and a recession, to name a few of the “biggies”.
- This is the worst half year start for bonds since nearly the start of this nation (1787). This viewpoint is in the eye of the beholder. The statement means that bond prices have decreased at a reckless pace on a relative basis from their beginning of the year price levels. In many fixed income buyers’ worlds, this is actually good news. The inverse relationship between bond prices and bond yields delivers significantly higher yields on bonds, a welcome win for income and cash flow buyers of fixed income. Now, can be one of the best times in many years, to shore up the fixed income allocation part of your portfolio.
- The 5 year Treasury was 1.26% at the beginning of the year. It is now 3.05%. 5 year AAA municipal bonds started the year at 0.57% and are now at 2.07% tax-free. BBB corporate 5 year bonds have moved from 2.00% to 4.66%.
- The futures markets price in what they believe will happen in the future. We often hang our hats on these indicators. The future does not always follow this script. In a recent example, the forward curve last year predicted that the Fed would not likely hike interest rates until 2023. So far in 2022, the Fed has three hikes for a total of 150f basis points (bp) and is anticipated to hike another 75bp in a couple of weeks.
- We “fear” a recession and we are experiencing inflation. Inflation affects 100% of the population and takes no bias as it negatively impacts all assets. For decades, deflation has been a bigger danger. Housing booms and years of stock market appreciation have provided a cushion for many portfolios but persistent inflation will eventually damage wealth. A recession mostly hurts people who lose their jobs. Is the Fed going to be forced to make a decision between the worst of two troubles?
- Ideally, we produce more stuff to bring down inflation. The Fed can’t do this. They can only try to make it more difficult for you and me to want to spend our money which has a negative impact on our wealth. The continued supply chain complications agitate the more desired solution path.
- The pandemic has changed our economy, or has it? Predicting when we snap back to a pre-pandemic economy might be an answer many of us haven’t come to grips with – never? A significant part of the desk workforce is either working from home or in hybrid work-from-home, work-in-the-office situation. Will this change the way consumers spend money? Our nation’s GDP is comprised ~70% on consumer spending. Cities are structured around a commuting workforce. Public transportation, lunch spots, clothing necessities, etc. Will durable goods purchases increase and certain service sectors decrease to reflect the acute change in consumer spending shaped by the pandemic?
- Inflation may be sticky. Global supply chains are stressed for a multitude of reasons. The bigger picture suggests that we are rethinking the way business has been done. We understand the dangers of relying on foreign producers for survival-sensitive products such as pharmaceuticals or any other health-sensitive circumstance. Increasing domestic production can be short-term inflationary as we build factories and have to pay higher domestic wages. In addition, our work-from-home consumption basket will likely increase goods we need and reduce services we used in our commute. The Fed can not readily change the effects of wage increases nor can they fix supply chain issues. Many new issues we face will continue to take time to rectify.
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 Securities Industry and Financial Markets Association’s Project Invested website and Investor Guides at www.projectinvested.com/category/investor-guides, FINRA’s Investor section of finra.org, and the Municipal Securities Rulemaking Board’s (MSRB) Electronic Municipal Market Access System (EMMA) at emma.msrb.org.
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