Despite widespread expectations that the Federal Reserve will raise interest rates three times this year, quality high-yield bonds continue to be favored by many portfolio managers. That’s despite historically paltry yields that continue to hover in the 4% or 5% area.
At Northern Trust Asset Management (NTAM), high-yield bonds remain the money manager’s largest overweight asset class. At present, NTAM is weighting these so-called junk bonds at 10% of model portfolios, up from its average allocation of 6%.
“We’re in an environment where investors are reaching for yield,” said Colin Robertson, chief investment officer of fixed-income. “I don’t think the Fed is going to raise interest rates as much as many investors think.”
Robertson believes that inflation should moderate to the 3.0% area in 2022. But over the next three years, he sees it trending back to below 2.0%, a view that the rates on 10- and 30-year Treasury bonds would appear to confirm. The 30-year Treasury bond has remained stubbornly below 2.0% in the face of noisy inflation headlines for more than six months.
Many bond market observers think if the Fed gets too aggressive raising rates it could invert the yield curve for Treasurys, a signal that a recession could be looming. That’s not an outcome the central bank would want.
“The fact that the Fed has thrown in the towel on the transitory [inflation narrative] is a good counter-indicator,” Robertson said. The biggest risk he sees in the return-to-low inflation scenario is “timing."
“I think inflation will start to slow in the next few quarters,” he continued. “Covid-19 is the biggest wild card.”
Before the pandemic struck early in 2020, there was a consensus that the coming decade would witness a continuation of muted economic growth and subdued inflation. The only factor contradicting this outcome was the effect of rising deglobalization on inflation.
However, the fashion in which the pandemic has upended the labor market has emerged as a new threat to anemic inflation. Robertson believes that the main area one might see more inflation is among lower- and middle-class wages.
That’s “not a bad thing,” he said. Indeed, low-income wages were trending higher before the pandemic struck. Now employers in the restaurant and hospitality industries are struggling to find workers.