Whither bonds? .

Finance
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Bloomberg is out there this morning with a rather negative projection for bonds generally:

This Is Now The Worst Drawdown on Record for Global Fixed Income

(Bloomberg) – Global bond markets have suffered unprecedented losses since peaking last year, as central banks including the Federal Reserve look to tighten policy to combat surging inflation.

The Bloomberg Global Aggregate Index, a benchmark for government and corporate debt total returns, has fallen 11% from a high in January 2021. That’s the biggest decline from a peak in data stretching back to 1990, surpassing a 10.8% drawdown during the financial crisis in 2008. It equates to a drop in the index market value of about $2.6 trillion, worse than about $2 trillion in 2008.

While there were signs the brutal selloff was easing on Wednesday, rising inflationary pressure around the world is fueling concerns about the ability of the global economy to weather any sustained period of higher financing costs. For investors, it means the allure of holding debt – even safe government bonds – is diminishing given how sensitive valuations are to interest rates, a measure referred to as duration.

“The safe haven attributes of Treasuries have been undermined when one adds duration risk to the equation,” said Winson Phoon, head of fixed income research at Maybank Securites Pte. Ltd.

That’s a blow to money managers accustomed to years of consistent gains, backstopped by loose monetary policy. The slump also poses a particular threat to the expanding elderly population in many major economies, given retirees are often heavily reliant on fixed-income investments.

The Fed raised interest rates by 25 basis points last week, and Chair Jerome Powell said this week it is prepared to increase them by a half percentage-point at its next meeting if needed. His hawkish tone prompted traders to rapidly ratchet up estimates for how aggressively the Fed will tighten monetary policy this year, with money markets pricing in the equivalent of seven more quarter-point hikes by the end of 2022.

“The headwinds for fixed income remain heavy,” said Todd Schubert, head of fixed-income research at Bank of Singapore. “Investors will need to recalibrate return expectations and be nimble to exploit market dislocations.”

The yield on 10-year Treasuries slipped two basis points to 2.36% as of 6:28 a.m. in New York on Wednesday, after surging to the highest level since 2019. Spanish and Italian bonds led the advance in Europe, with their benchmark rates falling three basis points.

Credit Risk

Higher borrowing costs risk further damping the return on debt, eroded by the fastest pace of consumer-price increases in decades. Soaring commodity prices following Russia’s invasion of Ukraine could worsen the outlook. Corporate bonds are particularly vulnerable to mounting stagflation threats, as slowing economic growth also raises credit risks.

Companies in the U.S. and Europe are set to avoid defaults thanks to healthy balance sheets and a manageable debt maturity schedule, Amanda Lynam, an analyst at Goldman Sachs Group Inc., wrote in a note to clients on Tuesday. Still, she sees the euro-denominated market as slightly more exposed if geopolitical tensions stay elevated for longer.

Global equities, meanwhile, are nursing losses of about 6% this year, even as stocks have bounced back in recent days as more investors bet they will help hedge against inflation. The retreat in both fixed-income and stock markets in 2022 is upending the dynamics of a classic 60/40 portfolio that is meant to balance out any losses from riskier share markets with the more stable cash flow of bonds.

The meltdown in global debt markets is a reminder of the Fed’s tightening cycle in 2018, though the broad global bond index wound up losing only 1.2% for that full year. But unlike four years ago, price pressures are now much stronger and the global supply chain is beleaguered.

For emerging Asia, the threat of stagnant growth and accelerating inflation adds to the upside risk for yields, according to Australia & New Zealand Banking Group Ltd.

“We are likely to continue seeing upward pressure on yields as we expect monetary tightening in a number of Asian economies to start in” the second half of the year, said Jennifer Kusuma, a senior Asia rates strategist at the bank.

Data on the Bloomberg Global Aggregate Index before 1999 is monthly rather than daily and the constituents and duration of aggregate indexes fluctuate. Fixed-income investors can still make money by betting against bonds.

Bonds are not looking all that great right now

Of course for every rule there is an exception :grinning::

And here it is

I hope! :wink:

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That exception is very limited by its annual purchase limits though. Better than nothing for sure, but at least for purposes of shifting a large position in fixed income, it seems to me to fall a bit short.

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Agreed. But of course worth maxing out nevertheless.

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It’s also too bad you cannot purchase them in an IRA to avoid federal taxation upon redemption.

But it’s a useful dip for the taxable portion of your investments. Kinda like CDs with interest rate indexed on inflation and moderate early withdrawal penalty. They were not good in low inflation environment but very useful currently.

My problem was the last time they were a good investment, it was followed by a long period of low returns which made me redeem them. At $10-15k/yr, that’s not good for building up a large enough position to be a meaningful part of income generation for my purposes. But I guess it could be a nice buffer for where to withdraw money from when equities and intermediate bonds are not doing so good.

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they are the best of a bad bunch but after taxes you are guaranteed to lose to inflation with i-bonds since they have zero fixed rate.

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Conceded

But it is very difficult today to locate investment opportunities which guarantee you will beat inflation and taxes.

My very best one right now is my side hustle. And with that I am barely, if at all, breaking even against inflation and taxes. I’m not paying any taxes on those gains, and still inflation alone is taking nearly everything. :frowning_face:

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I have always been a fan of govvies and I’m seeing an interesting offering this morning:

FHLB (Federal Home Loan Banks), their 0.25s of 12/28/23. These bonds are priced at a discount (as you would anticipate) of 96.766 to yield 2.131% to maturity. The bonds are callable at par - you should be so lucky!! :grinning: - with the next call on 06/28/2022.

Couple of comments:

Back in the old days I would study the call patterns across an array of govvie callables all from the same agency. This in an effort to score on the calls. It was a good way to make money fast while taking virtually no risk. That was then. This is now. I really do not know the call patterns of the FHLB. But you cannot do worse than 2.131% YTM in any event. And if your bonds should be called you take your significant other out to dinner! :wink:

To state the obvious, we are in an upward interest rate trend. Thus at this time bond buyers are wise to avoid any paper having a long duration. Sure you can reach for yield at the long end, but you’re probably gonna get your head handed to you as your bonds plummet in value should you be forced to sell. “Keep it short, keep it safe” always applies, but especially now.

So while the above offering is quite short, that is intentional.

If you happen to be unfamiliar:

Bond duration is a way of measuring how much bond prices are likely to change if and when interest rates move. In more technical terms, bond duration is measurement of interest rate risk

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note that

All interest earned from FHLB bonds are exempt from state and local income-tax, but are subject to federal income tax.

but this applies to the interest only. Since these are offered at a pretty steep discount, you will have to pay capital gains tax when you receive the par amount

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Gosh, many thanks. I didn’t even think of that! Guess this feature is more important in some states than in others.

Sure. I was thinking in comparison to CDs, where all of the interest also is subject to income tax, both state and Federal.

As for the capital gains, I guess that rate is no higher than your marginal rate, but could be less depending on how long you are able to hold onto the bonds.

Callable govvies are a crapshoot, but it is fun when you win and you never really lose provided you are willing to settle for the announced YTM. And of course bonds like this are really safe, so no worries about default.

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https://www.barrons.com/articles/bonds-interest-rates-51648221018

Based on futures trading, the Fed’s key policy rate—the federal-funds rate—is expected to end the year in a range of 2.25%-2.50%, according to the CME Group’s FedWatch site. That would include 50-basis-point hikes at both the May 3-4 and June 14-15 Federal Open Market Committee meetings, rather than the 25-basis-point moves that have been the rule in recent years. It would also be well above the 1.90% median forecast in the FOMC’s Summary of Economic Projections, released just on March 16.

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I used to like Barrons … a lot. Over the last decade or two, they remind me of the stock broker who contacts 1000 potential clients, gives advice to 50% and the exact opposite advice to the other 50%.

OTOH, they do offer some off-the-wall bets.

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Word on the street is there are some “trip/trip” four handle long bonds (agency bonds?) out there.

I have not located them yet, and of course long bonds are risky given rising interest rates.

But a four handle still is an attention getter. :wink:

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You could consider floating rate issues. They have a lot less interest rate risk (obviously, only until the time the floating kicks in), although they have credit and call risks as well. On the preferred side, if you want floating rates, there are C-N, NSS, CUBI-E, CBKPP among others… you can look up the details for these here

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Warning! Danger! Warning! Danger!

The long bonds presented below are subject to massive interest rate risk. This means, as interest rates rise, the value of these bonds (should you need to sell) will fall a great deal. That said, the bonds are dollar good, meaning if they are called at par or if you allow them to mature, you will get all of your money back.

These bonds might work for those focused on income. Where else are you today gonna get 4+% YTM on your money! Here we go:

FEDERAL FARM CR BKS
Cont Callable, Next Call 04-04-2023 @ 100.000
CUSIP: 3133ENTF7

These Federal Farm Credit Banks bonds are their 4.000%s of 4/4/2022. The bonds are continuously callable at par commencing one year hence.

Tax information on the bonds:

Under the Farm Credit Act, Farm Credit Debt Securities and the interest thereon are exempt from state, local and municipal income taxes. Provisions of several statutes that are analogous to the relevant tax exemption provisions of the Farm Credit Act have been construed by certain state courts as not exempting securities similar to the Farm Credit Debt Securities or interest thereon from nondiscriminatory franchise taxes or other nonproperty taxes imposed on corporations. Interest on the Farm Credit Debt Securities is not exempt from federal income taxation. In addition, gain from the sale or disposition of Farm Credit Debt Securities or their transfer by inheritance, gift, or other means is not exempt from federal taxation, and generally is not exempt from state, local or municipal taxation.

Interest on the bonds is payable semi-annually, April and October.

Ratings on the FFCB bonds bounce around. Sometimes it’s AAA, AAA-, AA+, and so forth. The bonds are dollar good. The principal risk you incur, as highlighted in the opening, is interest rate risk should you be forced to sell the bonds before they mature or before they are called.

These are the four handle bonds about which I wrote (not very far) up thread.

About the call:

Obviously, should interest rates descend, the FFCB will call these puppies in big time . . . and you will lose your bonds. So you cannot use these to lock in a 4% yield over the long haul. All calls are at par, though, so you will not lose money. You just get it back.

Compare that with a CD where you lock in your yield until maturity, like many of us did with Sharonview for example. Except today you cannot obtain CDs paying 4%. And these bonds DO pay 4%. That is the rub.

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‘The dam finally broke’: 10-year Treasury yields spike to breach top of downward trend channel seen since mid-1980s, says Deutsche Bank

Provided by Dow Jones:

By Christine Idzelis

Will the 10-year yield fall back down into the long-term channel?

Yields on the 10-year Treasury note have spiked through the top line of a downward trend channel tracing back to the mid-1980s, with surging inflation and the Federal Reserve’s reaction to it sparking questions over whether the long-term trend will imminently end, according to a research note from Deutsche Bank.

“Clearly such a channel can’t go on forever unless you’re of the opinion that we will consistently see negative nominal US yields in the latter part of this decade,” Jim Reid, head of thematic research at Deutsche Bank, said in an emailed note Monday that illustrated the downward trend. “So the near 40-year trendline will almost certainly have to end in the next few years regardless, but the recent spike in yields raises the prospect of it doing so imminently.”

"The dam finally broke last week with yields rocketing up as markets woke up to the reality that every upcoming FOMC meeting could bring" a rate hike of 50 basis points, Reid wrote in a separate note, on macro strategy, Monday. “An array of Fed speakers during the week either endorsed this or didn’t rail against it too strongly.”

There is more.

Read it here

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For anyone too lazy or ignorant to check, this bond matures in 2042. Although @shinobi put a BIG (and appropriate) warning at the beginning of his post, I wanted to reiterate the term of this bond. Four percent sounds great for the next year, or maybe two. I’ll put the obligatory “it also sounded great in the forties”. …that only reminds me of how old I am.

IM,NSH,O, you can expect rewards on this bond for the next 18 - 36 months. It will probably get called sometime after 18 months. I own this, or a very similar, bond. With current data, I anticipate selling it before August of of 2023.

Here are a couple of charts of U.S. 10 or 20 year bond rates. The only difference between then and now is the current VOLUMINOUS U.S. debt and the impending increase in that debt. That is no small difference. If the world awakens to the fact that we will never reduce our debt, the above bond will not be something to own for the long (10+year) term.

The image, alone, didn’t work, so here’s the whole article.

Not sure how long it’s going to take to render the above, but I’ll try adding this one, too.
In case the image never processes, here’s a link to it.

Processing: image.png…

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image
image741×640 122 KB

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I and others would benefit from further elaboration of your thinking. I have not read the prospectus for these, or similar, bonds. Since you own them, you probably have. However:

My best, although imperfect, understanding is that the bonds may be called at any time after one year. As I stated above, bondholders can anticipate a call should rates descend markedly below the subject coupon. The FHLB would call these four percenters and then reissue new bonds at the lower rate. This saves the FHLB money. That said:

I am unaware of any mandatory call provisions with this issue. Thus, should long interest rates remain generally high, bondholders would retain their bonds, like it or not, until and unless they sell. And if they do sell, it’s gonna be at a loss given prevailing long rates would be up.

So I’m forced to interpret what you wrote as your belief long rates will fall within eighteen months. This, of course, is possible. Nobody, myself least of all, can predict the direction of interest rates. I will risk saying lower rates eighteen months out would surprise me. But who knows.

Now you also mentioned possible benefit over thirty-six months. It is much easier for me to agree with that than with an eighteen month estimation. But if things are looking favorable (i.e., high rates are sustained) in August of 2023, why would you sell then and take a loss?

We both survived the late seventies and early eighties. We both know what it takes to knock out inflation, as taught by Chairman Volcker. And we both are aware this timid and hesitant Powell guy does not qualify to carry Volcker’s jock strap. It’s a shot in the dark. But I’m guessing this inflation will be with us for a while, together with higher interest rates.

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Interesting chart, xerty.

My own thinking is that, in order to snuff out inflation, interest rates must exceed the inflation rate. It would seem, from that chart, Powell has a way to go to meet that standard.

Back circa 1982-1983 I was able to snag some non-callable, highly rated, munis [I was buying munis in those days] having a YTM of 11%. Interest rates fell after that purchase and I held onto those bonds for the next twenty years, smiling like a cheshire cat. Ever since my eyes have been wide open looking for equivalent bond buying opportunities. And ever since I have come up short and been disappointed. It’s been four decades. But my eyes remain wide open. :wink: