Yahoo Finance Best bond bets for inevitable rate hike
Americans’ paychecks are growing, and this has some on Wall Street shrinking in fear of the Fed. The employment cost index, a measure of wages and benefits, climbed more than expected last quarter.
Within the ECI report, released last week, private-sector wages climbed at a 2.8% annual rate, the fastest pace since late 2008. Steve Huber, portfolio manager of the T. Rowe Price Strategic Income Fund (PRSNX), believes this helps set the stage for the Federal Reserve to nudge short-term interest rates from near zero within several months.
“We did get an uptick in wage pressure, which means we’re getting closer to full employment,” Huber says in the attached video. “The inflation data is where the Fed wants it to be; oil prices have stabilized and the dollar has stopped appreciating.” This means that the next couple of months’ worth of employment and economic-growth data will determine when the Fed will begin what it calls the “normalization” process for interest rates.
The upshot: a “September, or maybe December Fed tightening.” Financial markets last week began to adjust nervously to this prospect, it seems, with stock prices stumbling a bit and the yield on the 10-year Treasury note (^TNX) climbing above 2.1% for the first time in seven weeks.
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Still, Huber – whose fund invests in all types of fixed-income securities across the globe – doesn’t think the eventual first Fed rate hike will prompt a washout in bond prices (or a commensurate surge in yields) the way it did in, say, 1994.
Bonds with shorter maturities will likely bear the brunt of the policy change, but at the longer end of the Treasury curve the response should be fairly modest. Huber points to ultra-low global yields on European government debt as a factor that should leave Treasury yields rising only a bit. The upshot for investors is that safe yield will remain scarce, and income-oriented folks would “be very diversified here.”
He advises keeping some of a portfolio in Treasuries simply to maintain liquidity, while spreading bets broadly over various other sectors of the credit markets to find decent yields. “High-yield [debt] still looks attractive here in the near term, to us,” he says. Indeed, the standard high-yield, or junk, indexes now show yields near 6% on average.
And at least in the early part of the credit cycle, high-yield bond prices tend to hold fairly steady thanks to typically healthy economic growth and low default rates. Huber also thinks it’s worth sampling some emerging-markets debt, “where you can get some higher real [or inflation-adjusted] yield.”
Bottom line, though, he says as the Fed tightens in such a low-yield environment, “Staying diversified and keeping a portion in liquid securities is of utmost importance.” That slug of liquid, safer paper can act as a reserve of buying power to be reinvested at more attractive yields as rates finally go a bit higher.
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