Fixed income markets around the world have been affected by the global bond sell-off, and that certainly includes the U.S. bond market.
Key Takeaways:
- Fixed income markets around the globe are continuing to be rattled by the global bond sell-off.
- This sell-off, fueled by inflation and central bank policy, is pushing bonds yields up and making fixed income portfolios difficult to pilot.
- In times like this, opting for active short-duration bonds or CLOs could serve as a valuable safe haven.
To start, it’s crucial to contextualize why the sell-off is occurring. Broadly speaking, inflation remains a global problem, and central banks around the world are continuing their efforts to get prices down to acceptable levels.
In order to tame inflation, the Federal Reserve and other central banks have raised interest rates and otherwise kept monetary policy relatively tight. By doing so, they've kept bond yields up.
A Lose-Lose Situation
This isn’t the only challenge facing the fixed income market, however. With interest rates where they are, many governments are facing difficult borrowing rates when they issue public debt. Given that interest rates have been a persistent challenge for a few years now, this is becoming an increasingly large burden on national debt for a variety of countries. Again, this includes the United States.
“Even before the latest bond sell-off, their governments were forecast to spend 8% of tax revenues on net debt interest this year, as ageing populations and the threat of war are creating pressure to raise spending,” The Economist noted. “Now they must pay more to refinance their past debts, while many continue to borrow with little restraint. At some point investors will revolt.”
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The Buyback Backfire
We are already seeing difficult dynamics play out between the bond market and the federal government. Back in August, U.S. Treasury Secretary Scott Bessent announced that the Treasury would triple its buyback of government debt. In doing so, the U.S. Treasury's cap for buying government debt would increase to $6 billion, up from $2 billion.
This was done with the intent of addressing surging U.S. Treasury yields. However, many investors ended up selling some of their long-term bonds as a result. Of course, this only pushed yields higher.
Currently, the 10-year U.S. Treasury yield sits between 5.25% and 5.35% — far higher than many would prefer it to be. These numbers put 10-year Treasury yields at the highest levels since 2002.
The Case for Active Short-Duration Bonds
What does all of this mean for U.S. fixed income investors? Essentially, if investors haven’t begun pivoting more towards short-duration fixed income securities, now may be the time to do so.
See More: Got Interest Rate Worries? Consider Structured Credit
Short-duration fixed income can offer far less price volatility compared to its longer-duration peers. Long-duration fixed income securities, like 30-year bonds, can see significant price declines when yields rise, whereas short-duration U.S. Treasuries are far less affected.
These advantages are further amplified when approaching this slice of fixed income via active management. Active managers can play the short-duration fixed income market through both an offensive and defensive approach.
When the environment is more attractive for fixed income, these strategies can chase yield more aggressively and locate investment opportunities that index funds may miss out on. Conversely, when the bond market is faltering, active fixed income can be highly useful for defensive positioning.
A Chance for CLOs
Short-duration bonds aren’t the only vehicle for navigating a more volatile fixed income market. Collateralized loan obligations (CLOs) are also offering a compelling value proposition at this moment.
Part of this is due to the fact that CLOs operate with a floating-rate structure. In essence, CLOs adjust their coupon payments based upon changes within short-term interest rates. In a “higher-for-longer” interest rate environment, this can be a very effective boon.
CLOs and active short-duration bonds may be just the tip of the iceberg of effective fixed income solutions, but they are attractive tools nonetheless. For those looking to construct a portfolio to navigate rising yields and rate uncertainty, these approaches could serve as a valuable ballast to ride out any chaos in the fixed income market.
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