Bond yields show resilience despite hot CPI report

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Berro says Wednesday's move within the bond market has been "a rationale" one. She notes the Fed has been "holding on" to the idea that a June rate cut is possible, with a prediction of three rate cuts in 2024. However, that path has "narrowed," which has resulted in markets re-adjusting and pricing out rate cut expectations.

Berro names the two-year, five-year (^FVX), and 10-year (^TNX) yields as good entry points into the market for investors. She notes her focus on markets has shifted from the Fed's monetary policy path to "the strength of the corporate fundamentals" when it comes to fixed-income portfolios. Although conversations around "pricing out rate cuts" and potential delays have begun, she stresses what's also "important for investors" to consider right now: that the possibility of rate hikes is not on the table.

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Editor's note: This article was written by Angel Smith

Video Transcript

SEANA SMITH: We want to bring Kelsey Berro, JP Morgan Asset Management fixed income portfolio manager. Kelsey, it's good to see you. So just first your reaction to this move higher that we've seen in yields, and now that we're at that four or five level. Maddie was just mentioning 4.7% could be that next level to watch. What do you think?

KELSEY BERRO: So it's been a large move today, but it's also been a rational move. So the Fed has been holding on to the idea that they could cut as soon as June, and they could deliver three cuts this year. And that path to that outcome has narrowed a lot.

And as a result, the market has priced out the number of rate cuts to less than two. But I think that right now, we're dealing with some extremes. So if you look back to Q4, that was an extreme. Inflation undershot what the trend was, and the market way overpriced the number of rate cuts. They were pricing as much as seven or eight rate cuts.

Now, we're testing the other extreme. These extremes tend to create opportunities for investors. So if you were looking for that entry point to lock in yields, you've found another one today with this move higher, particularly in the front end.

MADISON MILLS: Right. I was just going to say, where is the best entry point for investors? So you're thinking two year?

KELSEY BERRO: Yeah, the two, and the five, and the 10 year, that intermediate part of the market. And I think the other thing that we're really focused on right now is not so much the path of the Fed, but it's the strength of the corporate fundamentals and the balance sheets of companies.

And so the primary place that we're focusing our risk budget in fixed income portfolios is actually on the credit side, and a little bit less on focusing on the day-to-day of what the Fed is going to be doing. Will they cut in June? Will they cut in September? Will they cut in December?

The key, though, is that, even though we're pricing out rate cuts, we're not talking about restarting rate hikes. And that's really important for investors right now. Yeah, we're talking about the Fed delaying, but we're not talking about a regime shift, where we're talking about rate hikes again.

SEANA SMITH: So the Fed does move sideways from here, meaning that they don't cut, but they're also not raising, so we're in this higher for longer environment right now. Do those trades, then, still make sense if we don't get a rate cut before the end of the year?

KELSEY BERRO: So I do think it still makes sense. So right now, what we're doing is we're looking at building fixed income portfolios that are relatively high quality but still can significantly outyield the US Aggregate Bond index.

So if you look at the US Aggregate Bond index, the yield is around 5%. It's probably a little bit higher after today's move. We can look across the universe, not just treasuries, not just the very high-quality stuff, but corporates, high yield, and build a portfolio with the yield around 6% to 7%.

And even if yields just stay around here, the return in your fixed-income portfolio should generally match the yield on the portfolio, assuming we're kind of in a stable range. So we do think it makes sense.

The pushback we hear a lot is that credit spreads are really tight so that incremental compensation that you're getting for buying corporates versus treasuries is small. We would say, yes, it is, but it's justified for the fundamentals.

And if you look at other time periods, where the economy was equally as robust, you saw similar periods where spreads stayed tight for a long time. And then those periods, it's best to stay invested in the market and collect that carry, clip that coupon, and get that income.

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