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As quantitative easing comes to an end, the markets attention has inevitably turned to the threat of rising rates. Nobody knows exactly when the Fed will begin raising rates. But when it does, analysts are warning it could throw the bond market into a tizzy.
But when they start raising rates isn’t the only question, how high they raise them is also causing concern. With some analysts warning that a stronger jobs market will cause the Fed to raise rates higher than had been expected.
Sparking fears bond investors will be caught out like they were in 1994. Or worse. In 1994, the Fed, after more than a year of keeping its policy on hold, raised its target rate sooner and by more than investors had expected. In the three months after the first rate increase in February of that year, the Bank of America Merrill Lynch index of corporate bonds with maturities from 10 to 15 years fell 7.6%.
Few expect a repeat of the 1994 experience this time around. Then again, few expected the 1994 experience in the first place.
Moreover, as BofA Merrill Lynch credit market strategist Hans Mikkelsen pointed out in a recent report, today’s bond market may be far more vulnerable to shocks than it was 20 years ago.
Therein lies a conundrum for the Fed. The clearer it is about its intentions, the more likely it is some investors will jump the gun. Yet playing coy means the risks of a bond-market shock may grow larger.
For investors, the time has come to start treating bonds a little more gingerly.
Todays Other Top Stories
LearnBonds: – Bed bath and beyond issues bonds offering “real” returns. – In the post-financial-crisis world, cost cutting and stock buybacks have been the name of the game for many public companies. Concerning share repurchases, many companies haven’t been shy about leveraging up their balance sheets in order to have more funds available for stock buybacks.
ETF Trends: – Passive muni ETFs shed Puerto Rico exposure. – Passively managed exchange traded funds usually do not make wholesale changes to their portfolios. Most of the underlying indices for passive ETFs rebalance quarterly and even then, holding and sector changes often boil down to just a few basis points.
Bloomberg: – Hidden bond fees have regulators eyeballing dealers. – On the afternoon of July 14, a broker bought Illinois bonds for 96.3 cents on the dollar. A little over an hour later, the same bonds were sold to an investor for $1.01, a jump of almost 5 percent.
Bloomberg: – Wall Street job boom fades as Puerto Rico convulses. – Money managers in the municipal market are adding analysts at the slowest pace since before the financial crisis, a sign research staffs are able to manage the volatility stemming from beleaguered Puerto Rico.
ETF.com: – Midterm muni ETFs hit sweet spot. – Investment-grade municipal bond ETFs have now delivered nearly twice the returns relative to the broad high-grade bond market year-to-date, thanks mostly to ongoing supply/demand imbalances. But within the high-grade muni space, it’s intermediate-term munis that are proving to be one of the sweet spots.
Bloomberg: – Baltimore sells debt rated at 50-year high. – Baltimore, Maryland’s most-populous city, is selling about $64 million of bonds this week as the municipality’s general-obligation debt carries the highest credit scores in half a century.
Star Tribune: – Where have all the bonds gone? – Detroit’s bankruptcy trial will spotlight municipal bonds. A bigger issue is the short supply nationwide.
WSJ: – Heeding 1994’s bond-market lesson. – Nobody knows exactly when the Federal Reserve will raise rates. But when it does, it could throw the bond market into a tizzy.
Think Advisor: – Facing the yield challenge. – Heading into 2014, the consensus view was that U.S. bonds were on the verge of a major bear market and yields on 10-year Treasuries would end the year higher than their 2014 starting point of 3.03%.
MarketWatch: – Why it’s so hard to find a high-quality bond. – The concept that “demand is greater than supply” is a classic, if hollow, line in every financial pundit’s toolkit.
ETF Daily News: – Are Treasurys about to spike? – It pays to stay diversified among many asset classes, including bonds. Today, I’m seeing signs of U.S. Treasurys strengthening relative to corporate bonds (and probably in absolute terms as well). We can find out which one is likely to outperform the other by looking at a relative strength chart of two ETFs.
Global Finance: – U.S. Treasury bonds fall on upbeat economic data. – U.S. Treasury prices pulled back Thursday on an encouraging labor-market report, tilting the 10-year yield back above 2.5%.
Investing.com: – The 10-year Treasury yield could drop under 2.4%. – With each passing day it seems the bearishness towards bonds refuses to ease. Surveys by economists still show a heightened distrust for the Treasury market, even though prices have marched higher for the bulk of 2014. When we look at the weekly chart of the U.S. 10-Year Treasury (TNX) we can see that support may be under 2.4%, and if prices do in fact break 2.4%, that may open the next wave of shorts to get squeezed.
High Yield Bonds
Wolf Street: – How bad can the junk-bond sell-off get? So bad it’ll take down stocks. – Late Friday, when the strategy folks at Goldman Sachs downgraded global stocks to “neutral” for the next three months, they gave a reason that would have been peculiar in normal times: “a sell-off in bonds could lead to a temporary sell-off in equities.”
Investing.com: – Is the junk bond market telling us something right now? – Is the corporate high yield (i.e. junk-bond market) telling us something right now? My own opinion is that the S&P 500 needs a good flush, but our client portfolios are weighted towards the higher market cap end of the S&P 500.
Business Insider: – Everyone’s talking about how junk bonds are in a bubble. – What is the next bubble? After two big stock market crashes within a decade of each other, investors and stock market observers have been eager to find the next financial bubble. Enter high-yield bonds.
FT: – Foreign money returns to Russian bond market. – Outflows of foreign money from the Russian bond market due to the Ukraine crisis were almost completely reversed by mid-July, according to analysis by Standard Chartered.
The Star: – Why bond mutual funds are a great way to control risk. – Resist the temptation to sell your bond funds because of their low returns. They provide needed ‘ballast’ in the event of stormy stock markets.
The Telegraph: – How investors should react to a nervous bond market. – High-yield bonds can signal a shift towards risk aversion and the flight of traditional investors is cause for concern, writes Tom Stevenson.
FT: – Investors splash the cash and turn passive. – Investors are switching out of cash and pouring money into passive equity funds, bonds and relatively new assets that combine shares and fixed income in a show of confidence in the global economic recovery.
Businessweek: – No bonds, no problem as PIMCO increases bets using swaps. – If corporate bonds don’t trade frequently enough for you, one solution is to turn elsewhere.
ETF Trends: – Bill Gross ETF not affected by PIMCO’s increased use of swaps. – More investors are utilizing derivatives to make up for liquidity concerns in the fixed-income market. For example, PIMCO is using credit-defaults swaps as an alternative in its flagship fund, but the exchange traded fund version has been left out.
Gross: Focus on wages + core PCE this week. Jobs are a misleading statistical shell game. #Yellen wants wages at 3.0%
— PIMCO (@PIMCO) July 28, 2014
Go into a prime fund w a floating NAV & gating fees for 2bps more or an UST fund w none? Bullish short USTs at the margin
— David Schawel (@DavidSchawel) July 28, 2014
5s 30s one year forward is close to 115bps, not far from where they were on the eve of the 1st tightening in 1994.
— Ed Bradford (@Fullcarry) July 28, 2014