If the Federal Reserve reduces its benchmark interest rate next year, as many investors expect, then buying longer-duration corporate bonds now would be a smart move, according to Janus Henderson strategists.
“It would be hard to lose money by adding [long] duration” to a portfolio, advised Seth Meyer, head of fixed-income strategy at the investment firm, in a webcast Wednesday that offered Janus’ 2024 outlook.
Longer duration bonds, generally those with maturities far off in the future (as much as 10 years from issuance), are most affected by changes in interest rates. If a bond has a duration of eight years, then a one-percentage-point drop in rates would produce an 8% increase in the bond’s price.
In making such an arb play, Meyer added, “you have to be picky” and ensure that the bonds you add are backed by solid fundamentals such as strong balance sheets.
At the moment, spreads of corporate paper to Treasurys are relatively narrow, with investment grade bonds yielding just 110 basis points (each point is one hundredth of a percentage point) over government obligations, down from 140 last year. Junk bonds are 380 bps over, compared with 540 last year.
Meyer noted that CCC bonds, the lowest junk rating before default, were the best-performing fixed-income category this year, a sign that investors were optimistic about them amid lingering forecasts of a recession next year. CCC bonds yield an average 14% annually, while BB bonds (the highest junk rating) are at 6.6%.
Investor interest in longer-term bonds has been piqued lately, observed Lara Castleton, U.S. head of portfolio construction and strategy at Janus, who moderated the webcast. She pointed to the iShares 20+ Year Treasury Bond exchange-traded fund, which tumbled all year until mid-October, when healthy economic reports quelled widespread recession fears—and since, the ETF has rallied 14.5%.
Janus is in the soft-landing camp for the economy, meaning it believes a recession will be avoided next year. Meyer acknowledged that the cost of capital is higher nowadays, given the Fed’s tightening campaign, but also cited the futures market’s wagering that the central bank will lower rates in 2024.
There will be plenty of corporate bonds to choose among, with S&P Global Ratings forecasting nonfinancial bonds issuance to grow 12% this year from last year’s volume and then slow down to 3% in 2024, from this year’s total.
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Tags: corporate bonds, ETF, Federal Reserve, investment grade, Janus Henderson, junk, long duration, maturities, S&P