Bond Market Mess Means Opportunity for Client Portfolios

Kathy Jones of Schwab

In the current environment, Jones says, an investor can get 5% yields or higher in a high-quality intermediate duration portfolio of Treasurys and corporate bonds. It has been a long time since that was possible, and with the risk of recession rising, those yields may not be available next year.

“Staying too short means riding the yield up and down but missing the chance to lock in a higher income stream for longer,” Jones warns. “Even though bond ladders tend to do well over the long run, it is challenging when the yield curve is inverted.”

Of course, a ladder approach still means averaging into the market over time, without trying to predict where interest rates are going. As Jones points out, if the yield curve continues to invert, with short-term rates rising, the lower rungs of the ladder can provide added income. If the yield curve normalizes, with short-term rates falling as anticipated in 2023, then today’s yields are going to look attractive.

“I would point out that the yield curve is upward sloping in the municipal bond market, so that makes the proposition of locking in current yields more attractive than in Treasurys,” Jones says.

Retirement Investing

From her point of view, for those near or in retirement, this is a good time to take some duration risk to provide an income stream from high-quality bonds with some certainty. It may also be a good time to harvest tax losses in lower yielding bonds and reinvest, if that makes sense for the individual investors’ situation.

“Overall, however, for those using fixed income for capital preservation and to generate income, we see the current environment as positive,” she concludes.

‘Sharper, Shorter Cycle’

Looking forward, Jones says, it is “notable” that the Fed’s projection still shows the expectation that short-term rates will drop modestly in 2024 and further in 2025. It’s not the “hike and hold for a long-time” scenario many were expecting, Jones says.

“This is indicating a sharper, shorter cycle with short-term rates falling back toward 2.5% over the long run,” she notes. “Of course, these are just projections as of today, and there is a wide dispersion of views at the Fed. Nonetheless, it appears that the majority at the Fed see rates falling in 2024.”