Portfolio Intelligence podcast: Is there still time to move cash off the sidelines and into bonds?

Fixed income investments are subject to interest rate and credit risk. Their value will normally decline as interest rates rise or if an issuer is unable or unwilling to make principal or interest payments. Investments in higher-yielding, lower-rated securities include a higher risk of default. Municipal bond prices can decline due to fiscal mismanagement or tax shortfalls or if related projects become unprofitable.

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John Bryson:

Hello and welcome to the Portfolio Intelligence Podcast. I'm your host, John Bryson, Head of Investment Consulting and Education Savings here at John Hancock Investment Management. Today is January 30th, 2024, and I thought it'd be a great time to have Jeff Given, Portfolio Manager at Manulife, on to talk about fixed income. Jeff is the Co-Head of US Core and US Core-Plus Fixed Income here at Manulife Investment Management, and you can find his strategies through mutual funds, ETFs and SMAs. Jeff, welcome to the podcast.

Jeff Given:

Thank you for having me on, John.

John Bryson:

You got it. Hey, listen, I'm going to jump right in. When we look back at 2023, we saw rates on the 10-year Treasury go from about 498 in October, all the way down to below 400 basis points at the end of last year. We are getting a lot of questions from advisors right now, "Did I miss the move in bonds?" What's your take on that?

Jeff Given:

We don't think investors have missed the move on bonds. Maybe they missed the beginning of the move, but we don't think they missed the entire move. When you look at longer term, we’ve got to look at what the Fed said, right? The Fed has said that long-term neutral rate on Fed funds rate is 2% to 2.5%, depending on which Fed Governor you're talking to. That puts 10-year Treasuries between 3% and 3.5%. That puts five-year Treasuries sub 3%.

And so even if the Fed just goes to neutral, which means the Fed's not either stoking inflation or stoking growth, then rates still have a long ways to go. If the Fed has to become accommodative at some point in time, that puts Fed funds rates and the 10-year at a lower level. And so I think that when you look at the rate move, we might've missed the beginning, but there is still plenty of time moving cash off the sidelines from money markets to intermediate, from short duration to intermediate. We do believe that over the intermediate term, that plays into a better total return scenario than sitting on the sidelines.

John Bryson:

So you brought the Fed into the conversation. I want to go there next. I know they're meeting this week. What is your outlook on inflation and what the Fed's going to do going forward and how does that impact the fixed income markets in your view?

Jeff Given:

Yeah, so we do think inflation is continue to come down. When you look at some of the components, owner of equivalent rent being a big component of it, we do think that's going to trend lower still. It's been coming off, it's well off the highs. As everyone knows, when you sign a 12-month lease, it takes 12 months before that comes down. It's going to take a time to come down, but that's going to take pressure off inflation. Used car prices another one.

So we do believe it's going to trend down closer to 2%. We may not get there this year, but the markets are anticipatory and so they'll get there ahead of time. We do believe the Fed wants to cut rates three times. If inflation comes down and the Fed stays where they are, it is contractionary, it is restrictive. The economy has slowed some. So we do think the Fed's going to reduce rates through the course of year, maybe not as much as the market's priced in, but lower rates, and that should be supportive of bond market prices across the board. We should continue to see the yield curve steepen in that intermediate part of the curve and have rates drop more than the longer end of the curve.

John Bryson:

Right. So pivoting here a little bit, 2024 is a presidential election year. We've got that coming up later. How are you preparing for it in the portfolios and does it have an impact on how you invest?

Jeff Given:

We really employ a bottom-up approach. So we're not trying to make top-down macro calls because there's so many variable various outcomes that can come out of the presidential election. I wouldn't say that we're not paying attention to it at all, but what we're trying to do, find good companies, find good sectors in the bond market, and then as well, optimal position on the yield curve for the intermediate term. So we're not focused on the election. I think the election does mean the Fed, maybe they lower rates a little bit earlier than before as they don't want to mess around with interest rates in the middle of an election or start a move middle of the election. It probably means the government in general is a bit more accommodative because no politician wants to cut off the spending as they're about to get reelected. So it should be supportive for the economy, so it should be positive for the economy, but it shouldn't really impact the broader trend of the Federal Reserve or where rates ultimately end up.

John Bryson:

Okay, very good. Now, a trend we're starting to see here in investment grade corporate debt is that issuance is rising and their spreads over Treasury is falling. Does this concern you or does this set up an opportunity for you going forward?

Jeff Given:

Yeah, it's not all that surprising. Rates are higher, especially investment-grade companies. It's the highest yield you can buy good companies at in about 15 years. So it's not surprising that investors are in there, especially ones that are yield focused and not as much spread focused. It does provide opportunities to reduce some exposure to more cyclical areas of the market, get a bit more defensive, but it also creates opportunities to move into higher quality areas of the market, like agency mortgage-backed securities, where you're getting actually paid more to be in a high-quality area and no credit risk, very little prepayment risk in the mortgage market currently, and do it with picking yield, increasing the distribution of various products.

John Bryson:

I want to dig in a little bit more on the opportunities, but before I do, can you highlight for me the top risks you're keeping an eye on in the fixed-income space right now?

Jeff Given:

Yeah, I'd say that the top risks haven't changed a whole lot over the last year, but maybe a little bit more nuances. Is the Fed going to be able to time their rate cuts at the right point in time? Do they stay too long in a restrictive policy and that pushes the economy into recession? Do companies have a hard time ruling over debt? More and more high-yield companies have to come to the market over the next year and a half to two years. Are they able to access the high-yield market before the economy slows quite a bit? Will inflation continue slowing over the next year? I think similar themes to last year, I do think that we have taken the upside risk to inflation and the downside risk to bond prices and off the table to some extent, but I think the general themes remain the same.

John Bryson:

And like I said, you mentioned some of the opportunities you're seeing. Can you summarize for our listeners the biggest opportunities you see into 2024?

Jeff Given:

Yeah, so we mentioned one of them. Agency mortgage-backed securities, we think is a great opportunity. That market is cheaper than it has been over the last 10 years on a risk-adjusted basis. Meanwhile, other areas like investment-grade corporates are near the tightest levels that have been in the 15 years. So that creates one opportunity. But even within investment-grade credit, there are various opportunities out there. One we like is financial institutions, specifically the banking sector. For the same rating, same quality, maturity. An industrial company is trading 20 to 30 basis points below that of a financial institution, that usually trades on top of each other. Financial institutions have had a lot of issuance in the last year. They had to price it accordingly. Eventually that gap will close.

You can also take a look at areas like utility markets, which tends to be one of the richer areas in the marketplaces, now trading cheaper than industrials as well. Generally, people still pay the electric bill even in a recession. So it's a way to get a good consumer more non-discretionary areas of the marketplace versus consumer cyclical areas of the marketplace, that if the economy does slow, can be a greater risk. So definitely opportunities out there, even with spreads at the levels that they're at.

John Bryson:

Hey, Jeff, thanks so much for sharing your insights. What I took away from your comments were investors have not missed the move in bonds. It started, but there's plenty more left. We have a lot of opportunities going forward. Now is a great time to get out of cash, get off the sidelines and put that money to work. We've got a lot of different options that can help your clients to do that, so thanks for sharing that and thanks for sharing where you're seeing opportunities. I think that will get people more excited about where to go with their assets going forward.

Folks, as always, thanks for listening. If you want to hear more, please subscribe to the Portfolio Intelligence Podcast on iTunes or wherever you listen to your podcast. You can also visit our website, jhinvestments.com to read our viewpoints on all things investing, business building ideas, and much, much more. As always, thanks for listening to the show..