Recently, we had a chance to catch up with George Bory, Managing Director of Fixed Income Strategy and Product Specialists at Wells Fargo Asset Management on what’s driving the fixed-income markets and how investors can respond to a highly volatile environment for bonds. Here were the top 5 takeaways.
1. Expect low bond yields and slow growth over the near term.
Asset prices crept higher over the past month as the Federal Reserve (Fed) reinforced its commitment to keeping rates low and circulating liquidity through the financial system. The markets took this dovish policy message as a positive cue, with bond yields dropping across the board and credit spreads tightening. “The need for yield just gets more and more reinforced,” says Bory. “We think low yields are going to stay with us and the Fed isn’t likely to let up.”
2. The Fed’s inflation policy could be changing.
During its September meeting, the Fed is expected to talk about new methodologies for its approach to reaching target inflation. The Fed targets an inflation rate of 2%; central bankers want to target policies to an average over the cycle rather than a point estimate. “That could eventually mean that the Fed will allow inflation to move higher and stay higher for a longer period of time,” says Bory. “That’s probably many months out, but it’s a notable shift from current practice and it could weigh on markets.”
3. Don’t overreact to a weak dollar.
The past few weeks have produced an upsurge of worry that the U.S. dollar has fallen out of favor. While the greenback has come off its highs, Bory thinks concerns that the dollar will no longer serve as the world’s reserve currency are overblown. He notes that since its March peak, the dollar is down only about 9.5%, and remains in its historical range compared to non-dollar currencies. “I would characterize what we’ve seen as a normal cyclical downturn,” he says. “During periods of extreme volatility, there’s always a rush to dollars, and as that fear subsides, people start to move back into other currencies. But there’s no substitute for the dollar as a reserve currency.”
4. What to watch for during election season.
The Presidential election captures the lion’s share of attention, but the balance of power across Congress is more important. That said, outcomes that result in united government, with one party in charge of the legislature and the Presidency, could portend policy changes that would draw a meaningful response from the markets. The other wildcard would be developments that impede an orderly transfer of power, which could unsettle international investors. “At the end of the day, I am expecting that if the Democrats take the White House there will be an orderly transfer of power,” says Bory. “If that doesn’t happen, markets will react very, very negatively.”
5. How advisors can navigate this environment.
The likelihood of a long period of low rates means that yields matter. One strategy for securing yield and total return is to invest in the steepest parts of the curve and roll down them. To generate real yield on short-term assets, consider short-term high yield funds. “If you need real yield, you have to go down the rating spectrum,” says Bory. To hedge against U.S. dollar weakness, Bory suggests a small allocation to a diversified fixed income fund that holds some assets in non-dollar currencies. And when it comes to the impact of politics, remember that the Fed will react to whatever Congress does or doesn’t do. “They’re in control of the bond market and unlikely to relinquish control,” says Bory.
We’ll be back with more insights from George Bory next month. In the meantime, visit www.wellsfargoassetmanagement.com to read more thought leadership from our entire Fixed-Income team.