“You can get back into fixed income,” bond investors say, even before the Fed stops raising rates

By Joy Wiltermuth

By and large, the 10-year Treasury rate could be close to the top, says the Schwab strategist

Sharp days of volatility like those that have rocked markets lately can produce big winners and losers on Wall Street.

But the year’s wild swings have also dramatically repriced financial assets, pushing up corporate bond yields and providing more cover for a range of investors when earnings dry up or a recession hits.

“Fixed income is back in vogue,” said Michael Kirkpatrick, senior portfolio manager at Seix Investment Advisors, in an interview with MarketWatch. “You can invest in fixed income again.”

Investors are reeling from a historically bad patch for bonds, but also from the woes of the S&P 500’s roughly 22% year-to-date decline through Thursday. More recently, however, outside of previous US recessions, the debt issued by many of the companies in the index has offered some of the highest sustained yields on record.

“You really have to go back before the financial crisis to get returns in this neighborhood,” said Matt Daly, head of corporate and municipal teams at Conning, of investment-grade corporate bonds.

Returns at 6%-9%

It’s hard to talk about financial markets this year without acknowledging the key role volatility in the 10-year benchmark interest rate has played in the turmoil.

Yields across the rest of the bond market have also risen, dealing a serious blow to bond yields and dealing with sticker shock to households and businesses looking to obtain financing.

That could bode well for the Fed as it tries to tame inflation. More recently, however, investors are also hoping that the Treasury rate’s surge above 4% may reflect a peak range and hasten the end of this Fed tightening cycle before the economy falters.

See: Why Stock Market Investors Should Wait for the 10-Year Treasury Bond to ‘Blink’

Looking at corporate bonds in modern times or since the late 1990s, yields have rarely been this high outside of a recession (see chart).

The investment-grade ICE BofA US Corporate Index (green, above) was up about 6% in October, its highest since 2009. “That definitely caught the eye of certain accounts,” said Blair Shwedo, head of the Division investment grade corporate bonds trading at US Bank. “One benefit of the current environment for secondary trading in corporate bonds is that yields are quite attractive after years of essentially being near zero.”

A companion high yield or ‘junk bond’ index (blue) recently rose to a 9.5% yield after the UK bond crisis spilled over into US assets. The sell-off took US junk bond returns back to 2020 returns when credit markets froze at the start of the COVID crisis until the Federal Reserve fired a pandemic-support bazooka to support markets.

Due to volatility and higher costs, companies looking to use the US bond market for funding were less willing to do so in September and October, which is typically a busy period leading up to the year-end holiday. Or they came into the market for financing and paid.

Cruise operator Carnival Corp. (CCL) on Tuesday sold $2 billion worth of high-yield bonds that paid investors a 10.75% yield, according to the Financial Times.

Kirkpatrick von Seix, a high-yield bond investor, said that despite the recent turmoil and US inflation data showing little progress in retreating from a 40-year high, there has still been a fairly decent supply of higher-quality junk bonds.

But he also believes the strong rebound in financial markets this summer could provide a script for what happens when the 10-year rate finally stabilizes and the Fed stops raising interest rates.

“Eventually interest rates will go up too high and come down,” Kirkpatrick said.

10-year highlight?

Collin Martin, a fixed income strategist at the Schwab Center for Financial Research, said he belongs to the camp that believes the 10-year Treasury rate could be near a peak.

“It could go a little higher from here,” Martin told MarketWatch. “But overall it’s probably close to his advantage.”

Read: Vanguard ‘not confident’ US Treasury rates have peaked after painful bond market losses. Why “risk-reward profiles” still seem more attractive in fixed income securities

Investors also tend to romanticize before the 2007-2008 global financial crisis, when yields hit 5%, he said. “It wasn’t a perfect environment for a short period of years to get that kind of return.”

Individuals often gain exposure to US corporate bonds through bond funds and exchange-traded funds. The largest investment grade corporate bond ETF is the iShares iBoxx $ Investment Grade Corporate Bond ETF (LQD), while the two major junk bond ETFs are the iShares iBoxx $ High Yield Corporate Bond ETF (HYG) and (JNK) SPDR Bloomberg High yield are bond ETFs.

Von Conning’s Daly said “there is no shortage of risk” in 2022, but he also sees an opportunity to take “a well-calculated risk” in investment-grade corporate bonds at recent higher yields, even amid interest rate fluctuations and at ongoing price volatility Energy and geopolitical risks from Russia’s war in Ukraine.

“But we’re coming from a position of strength barring a deep recession,” Daly said of corporate balance sheets. “A vast majority of companies can survive, at least those that are investment grade.”

See: Stocks attempt a bounce as earnings season begins. Here’s what it takes to keep the gains going

– Joy Wiltermuth

(ENDS) Dow Jones Newswires

10/22/22 1137ET

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