In a low rate environment for bonds, with many bond issuers highly leveraged and possibly vulnerable in the next recession, hedging bets can be the best strategy, according to officials at the Schwab Center for Financial Research.
With interest rates expected to gradually rise several times over the next six months, they said at a Tuesday press briefing in New York City, laddering strategies often make the most sense for yield hungry bond investors seeking a steady income.
Kathy Jones, Schwab's chief fixed income strategist, said the Fed will increase rates by 25 basis points every quarter for the foreseeable future and that long- and short-term interest rates are converging as the business cycle nears its end.
“If you’re investing for income, you can adopt a strategy for capitalizing on rising rates,” Jones said. She added that laddering “is so simple and so intuitive for our retail clients."
As bonds mature, the investor can use the strategy to reinvest at higher rates. Jones said retail investor with as little as $20,000 can use the strategy, but it is more effective to begin with $100,000. The latter figure allows one “to get enough diversification,” she said.
Another benefit of the strategy, she added, is that it is versatile: It can be used with munis, corporates or treasuries.
The strategy can also be used to set up a monthly income stream for “the retired investor who is used to getting a regular paycheck so you can get a monthly income. And I like this strategy because it is simple. You don’t have to be a rocket scientist to use it,” said Jones.
Another characteristic of this bond market is that long- and short-term rates could converge.
A flat yield curve is probably two to three rate hikes away, said Collin Martin, the Schwab Center’s director of fixed income. And he added that flat doesn’t necessarily mean the bond market is in danger.
A flattening yield curve could be the result of long-term interest rates falling more than short term rates or short-term interest rates rising than faster than long term rates. A flat yield curve is often an indication investors or traders are spooked about the economy.