Headline CPI came in at +0.4%, double market expectations, bringing the year-on-year rate to +8.2% versus the consensus estimate of +8.1%. Core CPI was hot at +0.6% against economists’ expectations of just +0.4%. Yield jumped and stock futures fell immediately after the higher-than-expected inflation data.
The US 2-year yield hit its highest level since 2007 as the federal funds terminal rate soared to 4.83%, up about 0.2 percentage points. Interest rate swaps now fully price in a 75 basis point rate hike in November. The likelihood of a massive full percentage point increase is now close to 20% when meeting in less than three weeks.
IPC data: hot at all levels
Components of the overall CPI
US 2-year yield climbs to 4.5%
The core CPI rate of +6.6% YoY is particularly worrisome as it shows that underlying inflation remains extremely high, making the Fed’s job all the more delicate. At the same time, the Fed is now more emboldened to raise its key rate quickly. The annual core CPI rate is now at the highest level since 1982, according to Bloomberg.
US core CPI: highest since 1982
Futures were higher ahead of the news report that UK tax cuts would be undone, but that optimism quickly evaporated as the reality of high inflation fueled fears again. investors. The US dollar hit a 24-year high, and crypto and oil prices also fell. Nasdaq futures fell to the lowest level since July 2020 while the US 30-year rate touched 4%, the highest in more than 11 years.
High-duration corporate bonds suffered a tough sell-off, but that means expected forward yields are much more attractive today.
According to Vanguard, the Vanguard Total Corporate Bond ETF (NASDAQ: VTC) seeks to track the performance of the Bloomberg US Corporate Bond Index. The fund offers investors broad and diversified exposure to the high-quality US corporate bond market through a mid-duration portfolio, with exposure to short, medium and long-term maturities.
Although down 20% since the start of the year, the ETF has a low annual expense ratio of 0.04% against a category average of 0.60%. Its median intraday bid/ask spread is just 0.09% and has a 30-day SEC yield of 3.0%, but its yield to maturity (a better indicator of expected returns) is 4.8. % with an average effective duration of 11.4 years. Credit quality, however, is at the lower end of investment grade.
VTC: Investment-Grade, but low-end
While market interest rates have risen dramatically over the past 26 months, Treasuries and corporates have fallen sharply. VTC, like so many fixed income funds, is suffering its worst drop ever. Vanguard’s corporate bond fund is down 25% from its August 2020 high. After inflation and dividends included, this represents a total real return of about minus 30%.
VTC: below COVID thresholds
The upside is that bond investors finally have a host of solid choices in terms of maturity and credit quality. The daily WisdomTree dashboard shows what investment options are available in the fixed income space. VTC’s 34% weighting in the Vanguard Long-Term Corporate Bond ETF (VCLT) significantly extends VTC’s duration, so if rates continue to rise, expect to see more losses. Yet, after today’s decline, the fund is now showing a very positive real YTM close to 5%.
I would avoid the VTC, however. According to iShares, you can get a higher yield with a shorter duration by holding the iShares iBoxx $ Investment Grade Corporate Bond ETF (LQD). This fund has YTM close to 6.0% after today’s decline with an effective duration of only 8.25 years.
Bond Yields and Duration
Today’s CPI report again stunned traders. The Dow Futures went from 300 to 500 in minutes. Bond market turmoil is only getting worse after core CPI hit a 40-year high today. While it’s hard to consider buying bonds as rates rise month after month, the fixed income investing environment today is much better than it was two years ago. . I would go for LQD over VTC for higher quality corporate bond exposure.