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Bond Market Commentary

A Buying Opportunity

By Drew O’Neil
October 9, 2018

Since the FOMC began raising the Fed Funds rate in December of 2015, investors have been waiting for the yield curve to shift higher. Many of these investors have been disappointed as most of the increase we’ve seen in “rates” has been limited to the short end of the curve. This had led to a much flatter yield curve than we started with and relatively more value on the short end of the curve (inside of about 5 years), while the intermediate and longer parts of the curve missed out on the yield increases to the extent that everyone had been forecasting. For example, from 12/15/15 to 7/2/18, the 10-year Treasury had increased by only 61 basis points and the 30-year Treasury increased by just 1 basis point. Compare this to the 3-month Treasury, which increased by 168 basis points over that same timeframe. It is fairly clear that for most of this Fed rate increase cycle, a majority of the action has been on the short end of the curve.

The intermediate and long parts of the curve have had some catching up to do, and over the past month, these parts of the curve have gained some momentum. The 7, 10, and 30-year Treasuries have all increased by 33 basis points over the past month, compared to the 3-month which is up by only 8 basis points (see chart below). With these moves, the curve has steepened by about 11 basis points, as measured by the 10-year minus 2-year, over the past month.

So what does this mean to you as an investor?

  • The recent spike higher in yields may present a good buying opportunity for those who have been waiting for certain yield levels before putting their money to work.
    • A 5 to 10 year investment-grade corporate ladder can now yield in the low 4% range (depending on the exact credits).
    • A 5-10 year A-rated or better municipal ladder can provide taxable-equivalent yields north of 4% (depending on individual credits and tax levels).
  • No one knows what the future holds, but this move higher in yields puts current rates towards the top of many experts’ near-term ranges, meaning that for those who have been waiting for higher rates since the Fed began raising rates nearly three years ago, the time may be now (see graph below for the current yield curve vs. 3 years ago).
  • The prices of many bonds and other fixed income products are likely lower than they were a month ago (bond prices and yields move inversely).
    • The good news for investors in individual bonds is that regardless of this interim price movement, the bonds they hold will still mature at par and their coupon payments will not change (barring a default).
    • More good news is that these investors may get to reinvest their coupon and redemption cash flow at these higher interest rates, likely increasing their overall portfolio yield.

To learn more about the risks and rewards of investing in fixed income, please access the Securities Industry and Financial Markets Association’s “Learn More” section of investinginbonds.com, FINRA’s “Smart Bond Investing” section of finra.org, and the Municipal Securities Rulemaking Board’s (MSRB) Electronic Municipal Market Access System (EMMA) “Education Center” section of emma.msrb.org.

The author of this material is a Trader in the Fixed Income Department of Raymond James & Associates (RJA), and is not an Analyst. Any opinions expressed may differ from opinions expressed by other departments of RJA, including our Equity Research Department, and are subject to change without notice. The data and information contained herein was obtained from sources considered to be reliable, but RJA does not guarantee its accuracy and/or completeness. Neither the information nor any opinions expressed constitute a solicitation for the purchase or sale of any security referred to herein. This material may include analysis of sectors, securities and/or derivatives that RJA may have positions, long or short, held proprietarily. RJA or its affiliates may execute transactions which may not be consistent with the report’s conclusions. RJA may also have performed investment banking services for the issuers of such securities. Investors should discuss the risks inherent in bonds with their Raymond James Financial Advisor. Risks include, but are not limited to, changes in interest rates, liquidity, credit quality, volatility, and duration. Past performance is no assurance of future results.

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