With the expectation that the Federal Reserve will be able to deftly guide the economy into a soft landing, the spread between corporate bonds and safe haven Treasuries has been narrowing.
As the Financial Times noted, the spread between the two has narrowed to its smallest gap since March 2005, or almost 20 years. This portends to more certainty that the Fed’s balancing act between lowering interest rates and taming inflation won’t result in a recession.
However, that isn’t to say that all is well in the bond market moving forward and that fixed income investors should turn the risk dial higher. A forthcoming election could add a healthy dose of market volatility. And according to the Financial Times, “some fund managers fear the $11tn US corporate bond market is too complacent about lingering economic risks or possible turbulence after November’s presidential election.”
Essentially, the narrowing spread could simply mean that the proverbial soft landing is already accounted for by the bond markets. As such, investors have to be careful when approaching the bond market in the current environment.
“Broadly speaking, the market is entirely priced for a soft landing,” said Mike Scott, head of global high yield at asset manager Man Group.
Short-term bond funds have been the go-to strategy the past few years as the Fed was aggressively raising interest rates. In the current market environment, it might still be too soon to step too far out on the yield curve. So a middle-of-the-road option would be to go for bonds with intermediate maturity dates.
2 Intermediate Options From Vanguard
Fixed income investors who prefer the option of extracting more yield will want to consider corporate bonds. On that note, a fund worth considering is the Vanguard Intermediate-Term Corporate Bond ETF (VCIT).
VCIT seeks to track the performance of a market-weighted corporate bond index with an intermediate-term dollar-weighted average maturity. It primarily focuses on high-quality corporate bonds with maturity dates that fall between five to 10 years.
On the other hand, risk-averse investors will want to exercise more due diligence. In this case, because of market uncertainty with the forthcoming election, Treasury notes are always a prime option. To stay within the safe confines of U.S. government debt, consider the Vanguard Intermediate-Term Treasury ETF (VGIT). The fund focuses on Treasury notes that fall within that five- to 10-year maturity-date window.
For more news, information, and analysis, visit the Fixed Income Channel.