November Bond Report
AUTHOR: David Olnick, Investment Executive, All Seasons Wealth
The release of last week’s CPI report has sent equities soaring as well as bond yields plunging.
All components of the CPI report came in lower than expected and even though the year over year CPI remains elevated at 7.7%, investors appear to be gaining more confidence that we have reached, or are close to reaching the peak in rates. 5 year forward inflation breakeven rates remain below 2.50%. Even 3 year forwards are in the 2.50% range, meaning that investors do believe that inflation will get back within that range within those timeframes. If that does indeed turn out to be the case, then owning longer-term taxable bonds at near 6.00% yields or tax-exempt bonds in the 3.50% to over 4.00% range will turn out to be very rewarding investments. That is why I have been encouraging investors over the past several months to extend duration and lock in higher yields for longer.
The early reaction to last week’s numbers have the DOW JONES up by nearly 1000 points. Bond yields have plunged (higher prices) as the 2 year treasury note has fallen by 20 basis points today alone and 35 basis points over the past 3 days. The 2 year treasury note had recently traded as high as a 4.72%, suggesting the FED would take the Federal Funds rate to near 5.00%. Reaction this morning in the Federal Funds futures market suggests that may no longer be the case. The yield curve between 10 year treasury yields and 2 year treasury yields remains inverted by nearly 50 basis points, suggesting that ultimately, yields will be headed lower.
More and more economic indicators are flashing warning signs of an economic slowdown/recession. We already know that housing is in the midst of a significant correction. Facebook recently announced major job cuts and one has to believe that other large tech companies will be doing the same soon. Wall Street firms are also beginning to lay some employees off. Credit card usage is soaring as consumers are becoming more tapped out. At the same time, the savings rate is plunging putting a real squeeze on disposable income. The corporate bond market is beginning to show signs of stress and the recent plunge in the crypto markets are beginning to raise concerns about potential liquidity problems that could reverberate into other markets. The signs are building up that the U.S. economy “could” be headed into a meaningful downturn. That could then send bond yields much lower.
The FED is still VERY likely to raise rates another 50 to 75 basis points in the coming months. However, if these inflation numbers continue to trend lower then the bond market has already priced in those expected rate hikes and, depending on the severity of the downturn, could begin to price in even lower rates since the bond market is “forward looking”. The FED, at this point, is still playing catch-up while the market is looking ahead.
This is a time, in my opinion, for fixed income investors to continue taking advantage of high quality bonds offering high yields while avoiding the more riskier assets.
The foregoing information has been obtained from sources considered to be reliable, but we do not guarantee that it is accurate or complete, it is not a statement of all available data necessary for making an investment decision, and it does not constitute a recommendation. Any opinions are those of David Olnick and not necessarily those of Raymond James.
