On March 28, we published an article
stressing the importance of portfolio diversification, flagging a basket of USD-denominated bonds (including Unicredit, Barclays, Ford and Kraft Heinz) offering yields equal to or over 4% as of press time. Since publication, the prices of all bonds mentioned in that article have risen, pushing yields lower.
It would be interesting for our readers to know that prices went up substantially for all the issuances mentioned; Unicredit with maturity January 2022 (XS1935310166) is now offering 4.25% in yield compared to 4.5% a month ago and Intesa with maturity January 2024 (US46115HAP29) now offers 4.0% rather than the 4.5% seen in late March.
The Ford and Kraft Heinz issues have been tightening faster still; Kraft Heinz with maturity February 2025 (USU42314AA95) offered 4% one month ago and now pays just 3.2% in yield. At the same time, Ford’s May 2023 maturity (US345397XZ10) is now paying just 4% after offering a yield of 4.8% on March 28.
If you have not yet diversified your portfolio with these or similar fixed income assets, don’t worry: while prices have gone up, there are still good opportunities out there and it is certainly not yet time to sit out the rest of this rally.
The weakness in credit spreads seen in the last quarter of 2018 was caused by a ‘perfect storm’ of hawkish central bank policies, market volatility and poor economic data. In other words, it seemed like the world was coming to an end in December. Now, however, markets seem more confident about where things are headed despite a slower overall economy.
After all, a Sino-US trade agreement seems imminent, US and European economic data are surpassing (admittedly cautious) expectations and central banks have moved back to accommodation. With political uncertainty on the mend and a broadly dovish tack from central banks, it is only natural that asset prices will rise. Despite this, we strongly believe that US yields still represent a buy opportunity. Here’s why:
First, the Federal Reserve is nowhere close to returning to last year’s rate hike agenda. In fact, there might soon be a need to start cutting rates. We expect that today’s Federal Open Market Committee meeting will see Powell and company hold the benchmark rate steady to buy some time, with this agenda likely to remain in place over the summer until ambient global slowdown fears are either confirmed or dismissed this autumn.
Second, US rates are far more appealing than their global counterparts. While the Fed benchmark is set in range between 2.25% and 2.5%, the European overnight lending rate sits at 25 basis points (0.25%). This means that the Fed has plenty of room to prevent or soften the consequences of a recession, and at worst it can still cut rates by at least two points, so credit spreads can remain relatively supported in the event of a sell-off.
As such, we believe that the USD-denominated fixed income space still represents a solid opportunity, and that interesting returns can still be found. With prices on the rise, however, investors need to adjust their yield targets from where they were one month ago. While it is still possible to find corporate bonds with maturities up to five years paying 150 bps over Treasuries, they are fewer and farther between.
If investors want to stay in the short part of the curve in investment grade names, they should now target 100 bps over Treasuries, or 3.5% in yield. To get slightly more in yield, it is necessary to move lower in terms of ratings, or to longer maturities.
We believe that Ford remains attractive, being one of the few names in the IG space that still offers 150 bps over Treasuries. Aside from the aforementioned issuance maturing in 2023, investors might also consider Ford's 5.584% March 2024 note (US345397ZQ92) offering 4.25% in yield.
IG bond investors can still find good value in financials as well. If one is not keen on Italian banks, it is still possible to find senior unsecured notes offering approximately 100 bps over Treasuries while steering clear of perceived instability on the peninsula. One outlier in this space is Jeffries, which stands between an IG and a high-yield rating with Moody’s rating the bank Ba1, S&P holding it at BBB-, and Fitch at BBB.
Jeffries notes with coupon 5.5% and maturity October 2023 (US527288BE32) are offering a yield of 3.85% while peers offer 3.5% or below.
Speculative investors who are willing to consider lower-rated (but higher-returning) bonds will be surprised to see that the price difference between IG and HY corporates is marginal. For example, Netflix’s junk issue with coupon 5.75% and maturity March 2024 (US64110LAG14), rated by Moody’s as Ba3 and S&P as BB-, offers just 3.75% in yield. There are only a few exceptions worth noting here, such as Sprint 7.25% September 2021 (US85207UAE55) yielding 4.75% and the ultra-short Virgin Australia 8.5% with maturity November 2019 at 3.6%.
In these market conditions, however, we don’t believe that it is necessary to stay invested in the short part of the curve. In our view, investors are better off getting comfortable with longer maturities between seven and 10 years. If the Fed cuts rates before the end of 2019, and given the central bank’s stated desire to move out of mortgage-backed securities and into Treasuries, the mid-long part of the curve will benefit the most.
Investors should be careful to select risk in these maturities, however, as they will endure significant volatility in the case of a widespread sell-off.