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The Bond Market Is Waiting for the Fed

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What You Need to Know

  • Anders Persson, Nuveen's chief investment officer of Global Fixed Income, offers his bond outlook.
  • “Fed patience for 2021, Fed taper 2022 and Fed tightening 2023” is how Persson describes his Fed expectations.
  • He favors, in declining order, leveraged loans, high-yield bonds, non-fixed preferred securities and emerging market bonds.

Ten-year Treasury yields have retreated from recent highs, bringing some respite to a market that appeared to be obsessed with the threat of rising inflation after the year-over-year  increase in the Consumer Price Index for April showed the biggest spike in almost 13 years.

“Now the market is sort of priced for reality,” said Anders Persson, chief investment officer of Global Fixed Income at Nuveen.

The spread compression that has boosted the corporate bond market earlier this year is not expected to continue to the same extent, Persson said.

He favors bonds that pay a higher yield — the carry trade — by focusing on moving down the credit scale for corporate securities rather than moving out the yield curve. “I’m still concerned about rates moving higher,” Persson said.

He expects the 10-year Treasury will be “range-bound for a bit,” then move close to 2% by year- end as the economy continues to recover and inflation moves higher, but he sees those price increases as transitory, as the Federal Reserve does. “I expect rates will start coming back down mid-next year,” he says.

Persson anticipates the Fed will signal that it is preparing to taper Treasury and mortgage-backed securities purchases — now totaling $120 billion a month — around August or September but not formally announce those plans until late in the year followed by implementation.

“Fed patience for 2021, Fed taper 2022 and Fed tightening 2023,” is how Persson describes his Fed outlook. “The Fed is very patient. The market is looking for cracks in the armor.”

Fed Governor Richard Clarida told Yahoo News on Tuesday, “There will come a time in upcoming meetings, we’ll be at the point where we can begin to discuss scaling back the pace of asset purchases … it’s going to depend on the flow of data that we get.”

A key data point to be released this Friday is the personal consumption expenditure price index, the Fed’s preferred inflation indicator. Also important will be the next report for the Consumer Price Index, which surged over 4% in April, and wage data, Persson said.

In the meantime, he favors, in declining order, leveraged loans, which have floating rates that reset every three months; followed by high-yield bonds; non-fixed preferred securities, which also have floating rates; and emerging market debt. A recovering global economy supports all four.

“The fundamentals are attractive for senior loans,” Persson said. He expects default rates to fall along with a recovery economy and continued strong inflows from retail and institutional investors, which have totaled $21.5 billion in the past 19 weeks, reversing about one-quarter of the outflows in the two years ended Dec. 31, 2020. The S&P LSTA Leveraged Loan Index has a yield of 4.3%, higher than the yield for the high-yield bond index.

In the high-yield bond market, Persson says, B-rated bonds represent the “best value,” and in the investment-grade market he is  “comfortable” with BBB-rated securities.

Non-fixed preferred securities are well-positioned for a rising rate environment because the primary issuers are banks and financials which benefit from a steeper yield curve, Persson said.

Pictured: Federal Reserve Building in Washington, D.C. (Image: Shutterstock)