By Amey Stone
The Federal Reserve has finally started cutting interest rates. That doesn't mean bond volatility is going away.
The Fed cut rates on Sept. 18 by a surprisingly large amount -- half a percentage point, instead of the quarter-point move widely expected. Bond prices move inversely to yields, so bond prices should have risen, right? Wrong.
The yield on the benchmark 10-year Treasury note rose after the rate cut and stayed there this past week, climbing to 3.78% on Sept. 26 from 3.62% on Sept. 16. Bond prices fell -- and not just Treasuries. The $121 billion iShares Core U.S. Aggregate Bond exchange-traded fund (ticker: AGG), which holds mostly Treasuries, corporates, and mortgage-backed securities, slipped 0.5% in the week following the rate cut.
Michael Arone, chief investment strategist at State Street Global Advisors, thinks the 10-year Treasury rate will continue to be volatile. Bonds had already rallied ahead of the Fed's move, following a "buy on the rumor, sell on the news" pattern. In a similar soft-landing economic environment in the mid-1990s, yields bounced around for months after the first rate cut before they eventually began to fall, he says.
For now, strategists recommend avoiding long-term bonds and popular ETFs like iShares 20+ Year Treasury Bond $(TLT.AU)$ or Vanguard Extended Duration $(EDV.UK)$. "The window for that is gone," says Eric Freedman, chief investment officer at U.S. Bank Asset Management.
Intermediate Treasuries and investment-grade corporate bonds are "the sweet spot" now, says Arone. With maturities in the three- to seven-year range, they have less interest-rate risk than long-term bonds, but investors will still benefit from price gains should rates fall. And yields are comparable with short-term bonds. Two ETFs his firm offers -- SPDR Portfolio Intermediate Term Corporate Bond $(SPIB)$ and SPDR Portfolio Intermediate Term Treasury $(SPTI)$ -- yield 4.5% and 3.6%, respectively.
Arone also likes the SPDR Blackstone High Income ETF $(HYBL)$, which his firm manages in partnership with Blackstone. It includes a mix of higher-yielding fixed-income securities, including high-yield bonds and collateralized loan obligations, and yields 7.38%.
For investors who can handle some risk, there are additional good options. The current environment makes a good case for preferreds, says Jay Hatfield, chief investment officer of Infrastructure Capital Advisors. They often sport a floating rate, which reduces interest-rate risk, and offer tax benefits, and many are issued by banks, which perform well as the yield curve steepens. His firm's Virtus InfraCap U.S. Preferred Stock ETF (PFFA) yields 8.85%.
Catastrophe bonds are attractive, says U.S. Bank's Freedman, since they don't correlate with stock or bond markets. Rather, their returns are tied to natural disasters and insurance premiums. He also suggests that investors seeking yield consider senior loans and high-yield municipal bonds and take a look at closed-end fund options in those sectors.
Bill Sokol, a product manager at VanEck, likes emerging market local currency bonds. They should benefit from higher commodity prices, and the rate cuts should remove some headwinds from the stronger dollar, he says. His firm manages the VanEck J.P. Morgan EM Local Currency Bond ETF $(EMLC.UK)$.
For risk-averse investors, cash isn't such a bad place to hang out, even as yields fall. Large money-market funds still earned 4.82% on average as of Sept. 25, according to Crane Data. That's down from 5.06% the day of the Fed rate cut, but still a healthy yield and a haven from ongoing interest-rate volatility.
Write to Amey Stone at amey.stone@barrons.com
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September 27, 2024 01:00 ET (05:00 GMT)
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