The Fed is expected to hike rates in December as the stars have aligned over the past few weeks: the Fedspeak, the economic data and markets are all priced-in and well anticipated and nobody would be surprised, said John Bellows of Western Asset Management.
But the bigger question remains what would drive long-term bond yields and it’s unlikely a 25 basis points change at the front-end of the yield curve would make a big impact to 10-year and 30-year maturity bonds as they are driven much more by inflation and growth. Investors would be better served if they look at fundamentals rather than focusing on the Fed, he noted.
US 10-year Treasury yields have jumped to more than 2.3 percent, indicating the bond-market has already moved even though the Fed has not officially moved yet. Asked to comment, John said investors need to look at different asset classes from a perspective; equities have generally done quite well in a risk-on environment and economic data have stabilized, which have contributed to the upward pressure on yields as well.
The rate-hike by the Federal Reserve would be a part of it, not the whole of it. There’s a bigger story at play right now about what’s going on with growth, inflation and risk outlook, and investors need to focus on them, he explained.
Most bond experts believe there’s a lack of liquidity in the fixed-income market and high-yield (junk) bonds have become dangerous due to widening spread between high-rated corporate bonds and Treasuries at a fairly rapid pace.
Asked if investors need to be worried about this trend, John said while high-yield bonds have underperformed, the interesting part of the development has been the growing disconnect between valuations and fundamentals.
Valuations are indicating a drastic scenario with higher default rates whereas the fundamentals are much more stable with stable corporate balance sheets amid a stable growth regime and accommodative monetary policy in the US. So, there’s a real disconnect between valuations and fundamentals and that’s likely to provide opportunities, particularly to long-term investors, he observed.
Asked if 10-year yields would rise in the event of a rate-hike by the Fed on December 18, John said rates are likely to remain in the same range where they are today. However, it’s likely to affect the stock market as equities tend to react to big events. But, corporate fundamentals and not the Fed is the main event, he concluded.
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