It could be a good time for investors to lock in attractive income in bonds, although selectivity is key. The Federal Reserve hiked interest rates on Wednesday, bringing the fed funds rate to 3.75% to 4%. It also signaled one more increase by the end of the year. While the 10-year Treasury yield initially moved above 5% after the announcement, it was slightly lower Thursday at around 4.95%. Bond yields move inversely to prices. “I’m not sure we’ve seen the top in yields,” said Brian Rehling, co-head of global fixed income and digital asset strategy at Wells Fargo Investment Institute. “I think the Fed probably has more work to do.” Bond yields, particularly on the 10- and 30-year Treasurys, had already been moving higher prior to the Fed decision, thanks to concerns about inflation, bond supply from artificial intelligence companies and the rising government deficit. Investors seeking total return, which includes price appreciation and income, may want to stick with equities right now since bond yields are expected to move higher, said Rehling. However, income-seeking investors can snap up some solid yields. “If you don’t care as much about the market price movement, and you can pick up 5%-plus yield … in investment grade or high yield [bonds],” he said, “that’s attractive because even if you have some price deterioration, you do have the coupon that cushions your total return.” Matthew Palazzolo, senior investment strategist at Bernstein Private Wealth Management, also thinks the recent move higher in Treasury yields is a great opportunity for income investors. “That just pushes up overall rates and provides them with a nicer amount of income. And importantly, and as we’ve been saying for our clients, this provides an attractive entry point,” he said. Income opportunities Investment-grade corporate bonds make a lot of sense right now because the economy is expected to continue doing well and corporate fundamentals remain strong, Rehling said. Investors can also add some exposure to high-yield, but they should stick with higher-rated companies since the elevated yields are going to be a drag on the weakest names, he added. He would also stay with shorter-maturity bonds, two years or less — and no more than five years. For its part, the UBS chief investment office sees select opportunities across regions and market segments. “Investors should calibrate both credit risk and duration to their objectives and investment horizons,” wrote Ulrike Hoffmann-Burchardi, chief investment officer for the Americas and global head of equities at UBS Financial Services. He suggests investors consider selectively adding duration in high-quality bonds. “Alongside attractive income, these securities have scope for price gains if tighter monetary policy slows growth or reduces longer-term inflation expectations, leading yields to decline” as bond prices rise, he said. Investment-grade corporates offer attractive income at intermediate maturities, while higher-risk credit — such as high-yield and emerging market bonds — should have short-dated exposure, he added. Tax-free yields This is also a good time to buy municipal bonds, said Bernstein’s Palazzolo. Munis are free of federal tax, and, if the holder lives in the state in which the bond is issued, exempt from state taxes as well. “To buy municipals here, yielding the levels that they are, [you are] not only starting with a nice beginning level of income, but even if rates begin to move higher still, you’re protected against that duration because you’re collecting a good amount of income,” he explained. He tends to favor muni portfolios that have a duration of about six years, with nice income and little interest-rate sensitivity. No ‘immediate’ return to 60/40 In addition to income, bonds may also provide ballast in broader portfolio. “Higher starting yields reinforce bonds’ role as a key source of portfolio income, while high-quality bonds can provide valuable diversification if economic growth slows,” Hoffmann-Burchardi at UBS said. Goldman Sachs is wary of the 10-year Treasury right now and doesn’t see an immediate return to a traditional 60/40 portfolio. “We see a case for a return to more ‘normal’ strategic bond allocations but the tactical case for adding long-dated bonds is mixed,” Goldman analyst Christian Mueller-Glissmann said in a note Thursday. Energy bottlenecks and central bank policy will likely drive both bonds and stocks in the near term, with rate relief supporting both but yield increases weighing more on equities. “That said, over longer horizons, higher starting yields should lift optimal bond allocations from the unusually low levels of the past five years towards historical norms,” he wrote.
