Drew O’Neil discusses fixed income market conditions and offers insight for bond investors.
Short-term Treasury yields skyrocketed throughout 2022 reaching levels not seen in almost 15 years. In early October, the yield of the 6-month T-bill topped 4% for the first time since 2007 and by the end of the month had topped 4.5%. This understandably got many investors interested and brought a lot of money into short-term fixed income investments. While yields north of 4% are attractive for a short-term investment, these investments are just that: short-term. For the investors that purchased 6-month T-bills last October, those investments are now maturing. As yields are quoted on an annualized basis, these investors earned holding period returns on these investments in the low 2% range. Now what?
Short-term yields are still attractive but taking a longer-term view often makes sense when it comes to investing in fixed income. Purchasing short maturity fixed income investments currently provides attractive yield levels but also comes with near-term reinvestment risk. Staying with the 6-month T-bill as an example, an investor will have to reinvest every 6 months at current market rates. If rates move higher you get to reinvest into a higher yielding investment but conversely, if rates move lower, you reinvest into a lower yielding investment. As most market participants are calling for lower yields by the end of the year, it is worthwhile to consider if you want to expose yourself to reinvestment risk 6 months from now. The chart below shows the forecasts for 2, 5, 10, and 30 year Treasury yields over the next few years, according to Bloomberg data.
Determining the purpose of your investment allocation can help you decide if short-term securities make the most sense. For long-term fixed income allocations, a primary benefit, barring default, is the known aspects that a portfolio of individual bonds can provide (known cash flow, known income, known principal return amount and date). The longer the maturity of the bond, the longer the cash flow and income are locked in. Yields across the intermediate and long parts of the curve are at some of the most attractive levels we have seen in the past 10+ years. For longer term fixed income allocations, locking in these yields now rather than keeping money in short term investments (their corresponding reinvestment risk) might optimize long term earnings.
