Drew O’Neil discusses fixed income market conditions and offers insight for bond investors.
- The FOMC lowered the Fed Funds rate by 50 basis points at their September meeting. This was the first cut in over four years and the start of what is expected to be a multi-year easing cycle. According to Bloomberg calculations, the market is pricing in 25 basis point cuts at each of the next two FOMC meetings (November 7th and December 18th). Looking out to 2025, there are four additional 25 basis point cuts priced in for the year which puts the cumulative expected Fed Funds cut at 150 basis points between now and the end of next year. It is important to note that these are somewhat long-term market expectations that can, and often do, change significantly as time passes.
- Over the past month, Treasury yields have fallen on the very short end of the curve (6 months and shorter) while moving higher across the rest of the curve. Yields from 2 to 30 years are 33 to 39 basis points higher month-over-month while 2- to 6-month yields are 7 to 12 basis points lower. This curve movement is not surprising given the influence that changes to the Fed Funds rate have over the shortest-maturity bonds while the longer maturity yields tend to react to longer-term outlooks for macroeconomic trends. The 10-year yield is back above the 4% threshold after touching a low of 3.62% a little over a month ago.
- The tightening trend continues for investment-grade corporate bond spreads. Both A-rated and BBB-rated 10-year spreads are approaching their lowest levels of the past two decades. In addition to spreads being compressed, the difference between the A-rated and BBB-rated curves is also relatively narrow. The difference between the two curves ranges from ~30 to 40 basis points across the maturity spectrum.
- Despite the spread tightening in corporate bonds, the yield opportunities remain attractive from a historical perspective. The yield on the Bloomberg US Corporate Bond Index is ~4.93%, which is nearly 150 basis points higher than its average since 2010. Short and intermediate maturity corporate bond portfolios are yielding in the mid to upper 4% range, which for many investors exceeds target returns for their fixed income allocation. Extending out in maturity and locking in these yields while they are still available makes sense for many investors.
- Muni-Treasury ratios, a measure of relative value between tax-exempt municipal yields and their taxable counterparts, have remained in the mid-to-upper 60% range across the short and intermediate part of the curve since early summer. Out past 15 years, ratios climb higher, peaking in the low 80% range on the long end of the curve. By both this measurement of relative value as well as absolute yield levels, the longer half of the municipal curve continues to provide a very attractive opportunity for higher tax bracket investors. Taxable-equivalent yields in the mid 6% range are readily available for those in the top tax bracket. For more information on the current state of the municipal bond market, read Monday’s MBIW by Gina Fay.
- Nearly $6.5 trillion is currently being held in money market funds according to ICI data. The generic money market yield, per Bloomberg, has fallen ~80 basis points since June, from ~5.32% to 4.56%. For investors with their longer-term fixed income allocation sitting in a money market fund, extending out on the curve and purchasing individual bonds now will lock in currently available yields for a longer period of time rather than the likely alternative of watching money market yields continue lower as the FOMC progresses through their rate cutting cycle.
