Money, it’s a gas (and cheap)

 

interest ratesJim Grant, of ‘Grant’s Interest Rate Observer,” opines that extraordinarily-low interest rates could be holding back hiring. Mr. Grant points out that it might be more cost- effective to finance equipment at low rates than adding workers. We agree that, in many instances, companies are better off adding or modernizing equipment rather than adding U.S. workers. After all, an A-rated corporation can borrow money for three years at about 1.20% and for five years at about 2.05%. We could see how, in some situations, a business might wish to choose equipment over workers. Prevailing fiscal policies do little to help the plight of workers.

 

To see a list of high yielding CDs go here.

 

Raising interest rates might not necessarily cure the hiring problem. There is still a global competition for jobs. Raise interest rates enough for equipment financing to be considered expensive and the choice for some businesses might come down to Tennessee or Thailand. If labor costs remain high, Thailand could win out. Also, higher interest rates could crimp the housing and automotive sectors, areas of the economy (along with energy) most responsible for drive the current economic expansion.

This all comes down to a scenario in which the U.S. experiences mild inflation, modest wage growth and moderate job growth. The world is becoming flatter every day. This should keep wage and inflation pressures modest. In economies experiencing declining populations (such as Japan), deflation could be an ever-present threat. A flat world could mean lower interest rates than to what investors have become accustomed for an extended period of time.

What are fixed income investors to do? Lower rates (lower cyclical peak rates) could result in more muted duration-related volatility than many experts have forecasted. This means that extending out ten or fifteen years on the long end of a bond portfolio might not be as harmful as some investors believe. This is especially true when one considers that one can hold bonds until maturity and that, as time passes, longer-term bonds roll in on the yield curve. I.E. In five years, today’s 10-year note is a five-year note.

Taking some degree of credit risk might make sense for some investors. If interest rates remain low and investor thirst for yield remains strong, corporate default rates could remain historically low. However, we would like to caution readers. Although corporate default rates could remain lower than “normal,” even modestly higher interest rates could result in increased corporate defaults. The increase in corporate defaults should come from the bottom up. By that we mean: It should be among the lowest-rated companies that an increase in corporate defaults should first materialize. It is for this reason that we do not favor CC, CCC or low-B-rated credits.

If investors insist on investing in credits rated below B, we suggest selecting bonds with maturities inside two years as rate should remain low enough to suppress corporate defaults within that time period. CCC exposure should remain within three years and B-rated investments within five years. We try to keep our BB exposure inside seven years. In our portfolios, we use BBB and A-rated corporate debt for the longer end (ten to fifteen years) of our corporate bond portfolios. In our municipal bond portfolios, we will consider fifteen and 20- year bonds (on a case-by-case basis), but rarely extend beyond 20-year as most municipal credit curves flatten significantly beyond that point.

By Thomas Byrne – Director of Fixed Income – Investment Consultant

thomas bryneThomas Byrne brings 26 years of financial services experience to Wealth Strategies & Management LLC. He spent the last 23 years as Director of Taxable Fixed Income for Citigroup, Inc. and predecessor firms in New York, NY. During the course of his long fixed income career, Mr. Byrne was responsible for trading preferred stock, corporate bonds, mortgage backed securities, government debt, international debt and convertible bonds. Mr. Byrne was also responsible for marketing, sales, strategy and market commentary within the taxable fixed income markets.

Employment

  • November 2012 – Present, Wealth Strategies & Management LLC, Stroudsburg PA
  • December 2011 – November 2012 – Bond Squad, Kunkletown, PA
  • April 1988 – December 2011, Citigroup and predecessor firms, New York, NY
  • June 1986 – March 1988 – E.F. Hutton, New York, NYThomas ByrneDirector of Fixed IncomeWealth Strategies & Management LLC570-424-1555 Office570-234-6350 CellE-mail: Thomas.byrne@wsandm.comTwitter: @Bond_SquadHigh yield/junk bonds (grade BB or below) are not investment grade securities, and are subject to higher interest rate, credit, and liquidity risks than those graded BBB and above. They generally should be part of a diversified portfolio for sophisticated investors.The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.

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