It’s a tough time to be a bond investor. Fixed income securities, which include products such as bonds, certificates of deposit and debt-linked mutual funds, had one of their worst quarters in decades.
High inflation has pushed some investors away from bonds – seen as a hedge against bear markets – as it eats into fixed income yields. In recent years, low interest rates have supported the investment philosophy that there is no alternative to stocks, dubbed TINA.
But what also happens when stocks crash? Recent market volatility has investors weighing weak bond yields with the need for a safe haven from equity declines. Such was the case on May 18, when the S&P fell 4%, driving demand higher as investors flocked to safety.
This created an unusual situation in that, for the first time since 1994, both stocks and bonds have been in the red since the beginning of the year.
Bonds are in a bit of a special situation, with inflation and rising rates pushing investors to sell bonds as inflation cuts their yields amid rising rates.
Michael Horan, head of trading at BNY Mellon Pershing, said there was market pressure to sell and buy bonds.
“The bond market reacted and you think, ‘I know inflation is here. I know the rate hikes are here and usually I will sell my bond to buy a new issue but I will buy bonds. I worry about the stock market, I worry about many other asset classes,” he said.
Episodes of bond stability have been short-lived. Federal Reserve Chairman Jerome Powell said he aimed to steer the U.S. economy toward a “soft landing,” while fighting a spike in inflation by aggressively raising interest rates and lowering interest rates. shrinking the central bank’s balance sheet, which hovers around $9 billion.
“Investors aren’t used to seeing dramatic losses in their bond portfolios, especially when stock markets are also down sharply,” said Saria Malik, chief investment officer at Nuveen, TIAA’s asset manager. says MarketWatch.
There is reason to be optimistic. Easing concerns over monetary policy and the looming risk of recession helped support markets last week – the relief rally was broad-based across assets and regions and bonds gained alongside state stocks -United.
The most common bonds provide a regular payment to the coupon holder, receiving a fixed income until the bond matures. When a bond matures, it also receives the face value of the coupon.
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The United States is a big piece of the fixed income market, representing 39% of the $125 billion market. The most commonly traded bond is the 10-year US Treasury note. The yield on this benchmark bond was approaching 3% at the end of April, the last time yields were at this level was in 2018. In the UK, the similar 10-year gilt has a yield of 2%, an unprecedented yield since 2015.
And then there’s the flea market.
Bonds are categorized as investment grade or high yield, with ratings primarily provided by the big three credit rating agencies – S&P, Moody’s and Fitch. Investment-grade bonds offer lower yields than high-yield bonds or junk bonds because investors seek a higher reward for assuming the higher risk of default.
Junk bonds, like their investment-grade counterparts, are also in a precarious position as investors begin to price in the possibility of a recession. According to Goldman Sachs research, $87 billion in US notional value junk bonds are at “distress levels”.
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