U.S. Bond Markets Forge on Despite Headwinds from Rising Rates

October 25, 2018

Rising interest rates may be reaching a level that matches U.S. President Donald Trump’s relationship with the media, but the president’s disdain for rate hikes won’t gain any sympathy from the Federal Reserve with the possibility of more hikes to come. Despite the Fed implementing its third rate hike this year, the bond markets are forging on as outlined in Winthrop Capital Management president and chief investment officer Greg Hahn’s latest report regarding the state of the fixed income markets.

Stocks and bonds typically march to the beat of their own dream, but lately, they’ve been moving in unison at times with yields rising, depressing government debt prices while U.S. equities sell off. The flight from bonds wasn’t relegated to the U.S. capital markets as debt sell-offs occurred around all parts of the world.

“Fixed Income markets across the globe experienced heightened volatility during the 3rd quarter, as domestic and international equity markets sold off, global growth slowed, trade concerns weighted on investors, and tightening Fed monetary policy collided in the cross hairs of the market,” Hahn said in the report.

In September, the Fed raised the federal funds rate by 25 basis points to its current level of 2.25, citing continued strength in the economy. As such, the path to higher rates would likely be sustained as long as the economic data continues to support growth.

Nonetheless, for the investors who managed to stay resilient in the bond markets, there were certain pockets of fixed income that have been able to stave off any negative impacts from the latest stock sell-offs and rising rates, such as investment grade credit.

“Despite rising yields, investment grade credit performed well during the quarter, with a total return of 0.89% for the Bloomberg Barclays U.S. Credit Index,” the report noted. “Investment grade spreads tightened 12bps during the quarter, as corporate earnings came in strong and profit margins continued to remain elevated following tax reform. In addition, a decline in corporate supply helped support tighter spread levels over the past quarter.”

For the average investor, it’s hard to imagine high-yielding debt to be associated with “safe,” unless the word “not” precedes it, but to fixed-income investors in the know, these bond have been anything, but junk in a rising rate landscape. As the curtain closes on the bull run and the late market cycle, the natural propensity for fixed-income investors is to shift back to safer government debt, but in today’s environment of rising rates, high-yielding bond strategies may be the safer option.

“High yield credit has been the one bright spot in a year of negative fixed income returns, returning 1.65% in 2018 for the Bloomberg Barclays High Yield Index,” Hahn noted in the report. “Spreads in high yield credit hit their tightest levels in 10-years at 312 bps. High Yield returns have been driven by lower grade credit where CCC have experienced a year-to-date total return of 5.27% versus -0.42% for BB bonds.”

The U.S. municipal bond market represents a $3.8 trillion pie and firms are already looking to get a slice. For example, Columbia Threadneedle Investments has the Columbia Multi-Sector Municipal Income ETF (NYSEArca: MUST) that incorporates rules-based and strategic beta strategies to suss out opportunities within the municipal bond markets.

For the right investor, the muni market could be rife with opportunities.

“Municipal bonds continue to offer a stable tax advantage income to investors in higher tax brackets,” Hahn noted. “Interest rates in municipal bond sector rose through the quarter by roughly 30 bps across the yield curve.”

At the conclusion of the report, Hahn offers his guidance for fixed-income investors by focusing on two investment themes — click here to find out more.

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