What the Bond Market Is Telling Fixed-Income Investors

What can we glean from recent action in the bond market? To be honest, very little, but that in itself is useful information. Let's start with the 10-year Treasury. 10-Year Treasury Yield: Has the Fed Already Implemented Yield Curve Control? I am being facetious in the chart's title. The Fed has not yet implemented yield curve control. That is where the Fed would set target yields on Treasury bonds, outside of the curve -- right now, it only sets the price on the Fed Funds Target Rate. Shifting to targeting yields would be a big step and one it would be reluctant to take (Japan currently does it, and the U.S. did it a long, long time ago). The Fed believes (and so do I) that controlling the yield curve is preferable to implementing negative yields. In any case, since March 31, the 10-year Treasury has closed in a very narrow range. Since June 18, the 10-year Treasury yield has been contained within a range of 0.61% to 0.71%. There are those who will tell you that these low yields indicate that the bond market is scared for the economy. That the bond market is pricing in doom and gloom. That is just not the case. What the bond market is pricing in is: A Fed that will be extremely reluctant to raise rates even if we get growth or inflation. If the Fed is set at anchoring the front end of the yield curve near zero, it is hard for the longer end to trade much higher. A Fed that will buy bonds and do everything it can to lower yields if the economy stumbles. Basically, the Fed has a lopsided reaction function right now. It will be quick to add monetary stimulus and slow to remove it. That is what bond markets are pricing in. Yes, the bond market is looking at economic growth etc., but it is constrained by the Fed's reaction function. It is actually pricing in much of what the stock market is pricing in -- weakness in many core sectors and some strength in some high-tech sectors. Corporate Credit Is OK Corporate Spreads: Almost as Dull and Meh Performance If you have not looked at corporate bond spreads in the past month, it might be easy to assume that we would be back to the tightest levels of the year. With headline after headline touting stocks returning to the highs and non-stop chatter about the Fed and Treasury buying corporate bonds and the massive inflows into fixed-income ETFs, it would be completely understandable to expect credit spreads to be tighter than we've seen -- but they aren't. The five-year CDS (credit default swap) market might be most baffling of all, as the SMCCF (Secondary Market Corporate Credit Facility) is actually buying bonds of investment-grade companies (as of March) with a maturity of five years and less -- the exact opposite of the bet that credit protection buyers are making. Yes, the record-setting supply of new corporate bonds is holding back credit spreads, but there is some caution here (especially on a company-specific level) that I think credit is sending a marginally more concerning signal than Treasuries - but still not saying a whole lot. What to Do? If you hold long-dated Treasuries (or an ETF such as iShares 20+ Year Treasury Bond ETF ), you might reduce your holdings. Yields will struggle to go a lot lower from here as the Fed seems very reluctant to enter the negative yield game. It could happen, but that would take a serious deterioration in economic conditions. On the corporate bond side, lighten up on high yield. Sell leveraged loans. Sell emerging markets (not quite corporate but will lump it in here). You can keep Investment Grade, but maybe sell there, too. If you have any closed-end funds that invest in bonds, take profits. Yes, it will hurt to give up the high dividend that these funds can pay, but the prices are too high and the discounts to net asset value (NAV) are too low to justify the risk. We will address munis in more detail in another piece as that market continues to march to the beat of its own drum and is highly dependent on policy coming out of Washington, D.C.

What the Bond Market Is Telling Fixed-Income Investors

Some will tell you that the bond market is pricing in doom and gloom. But is that really the case?

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