Recent economic and inflation data continue to validate the concerns echoed by our team in recent Strategy Updates as the Federal Reserve is now set to "double down" on their Hawkish – or aggressive – monetary policy path vis-a-vis raising interest rates at the fastest pace since 1994. The Federal Reserve has instituted several "jumbo" sized interest rate hikes in hopes of cooling inflation.
What does this mean for investors – particularly fixed income and bond market investors? In our view, this is a great time to be an individual bond investor. Treasury bonds are currently trading in the 3% range, and we are seeing high-quality corporate bonds yielding in the 4% range. Our firm continues to seize opportunities by actively buying individual corporate, municipal, and treasury bonds. We have been building out diversified portfolios of quality, investment-grade bonds in varying sectors. We currently are avoiding junk-rated and lower-quality bonds because they are negatively impacted the most during a recessionary environment; however, we would look to add some exposure here when we see signs of "The Big Five." Click here to read our most recent strategy update on five important factors that could end the bear market.
Now is a great time to lock in these higher rates in the context of your total portfolio return and financial planning. If you have a portion of your account designated to our fixed income strategy, we are actively building your bond ladder out 1-10 years. It is important to remember that interest rates are part of a cycle and bond prices rise and fall based on market expectations. Laddering bond maturities allow you to earn income and help to mitigate interest rate risk because you have bonds that come due at different times during the interest rate cycle.
Do Not Miss This Plane
Our team invests in individual bonds, which allow better control of duration risk, otherwise known as maturity risk. Think of the bond market as a teeter-totter with interest rates on one side and prices on the other. As interest rate expectations move up, bond prices – particularly those with longer duration – or maturity dates – suffer relatively steeper declines. By owning bonds with shorter duration, your fixed income portfolio has held up quite well, and now we have the opportunity to lock in yields we have not seen in over a decade. In contrast, many bond fund investors this year have double-digit declines – ouch! This is a key reason we favor owning individual bonds, despite the greater attention they require.
We believe now is an excellent time for fixed-income investors. Why so? For most of the last decade, the Fed funds rate has been anchored near zero. Fed rate hikes and the market's anticipation of future rate hikes have pushed up yields across credit curves. Bonds are currently yielding rates that we have not seen in many years. Rising rates have even injected life into money market funds which are currently yielding above 2%!
As discount mechanisms, markets tend to be forward-looking and price accordingly. Currently, the market sees the Fed terminal rate reaching 3.5-4% and the hiking cycle to end in the first quarter or so of the next year. As rate hikes begin to slow the economy further, we may begin to see more of a downward trend in rates. The market may begin to discount this prior to the end of the hiking cycle, so it is important not to miss the opportunity this present moment provides. Do not miss this plane!
In our view, the bond market has finally come back to life for savvy and patient investors. Bonds offer a variety of benefits such as steady income, capital preservation, and diversification from equity exposure. If you have significant cash sitting in savings accounts, checking accounts or bond funds, please consider reaching out to your team so we can help you achieve higher fixed income returns.
We hope this update on fixed income markets is helpful to you. If you would like to discuss your portfolio or have experienced any changes in your financial affairs, please let us know. As always, thank you for your vote of confidence in our work.
Your Team at MSR
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