Chan Jia Ying believes that the Federal Reserve has started an interest rate cut cycle in September this year, short-term interest rates will gradually decline, the Fed will cut interest rates by another 25 basis points in November, and is predicting a total interest rate cut of 125 basis points from December to next year.
According to the Wise Financial APP, the results of the US presidential election in November revealed that the Republican Trump won 312 votes, once again elected as the President of the United States. This result led to interest rate fluctuations in the bond market. Allianz's senior product specialist Chan Jia Ying believes that the Federal Reserve has started an interest rate cut cycle in September this year, short-term interest rates will gradually decline. Fed Chairman Powell also stated that inflation data is gradually easing, coupled with a slowdown in job growth. Therefore, whoever is in charge of the White House will not have a significant impact on short-term interest rates. The Fed will cut interest rates by 25 basis points in November, and is predicting a total interest rate cut of 125 basis points from December to next year.
Although the downward trend in US interest rates will drag down overall bond yields, the current short-term high yield bond yield is still as high as 7%. Furthermore, the current basic forecast is for a soft landing of the US economy, which makes the performance of high yield bonds relatively stable. It is expected that the short-term high yield bond yield will be between 6% to 7% next year. Even if the US falls into an economic recession, Chan Jia Ying believes that the default rate of short-term high yield bonds will not rise significantly. The reason is that the spread inversion has lasted for over two years, but the US economy remains resilient. Both large and small businesses have already prepared for a US economic downturn, with conservative debt issuance and a focus on cash flow. The leverage ratio will not be too high.
Chan Jia Ying stated that under the US interest rate cut cycle, US short duration high yield bonds will provide investors with attractive returns and lower interest rate sensitivity. As of October 31, 2024, the yields of US 10-year Treasury bonds and investment grade corporate bonds were 4.28% and 5.22%, respectively. The dividend yield of the S&P 500 index was only 1.32%, much lower than the average yield of 7.5% for US high yield bonds. This presents an attractive investment opportunity for international and domestic investors.
Chan Jia Ying mentioned that as of October 2024, the default rate of short duration high yield bonds was only 0.55%, much lower than the historical long-term default rate of 3.5%. Relatively speaking, there is greater uncertainty in long-term interest rates, with higher volatility. This is because there are many factors affecting long-term interest rates, such as market expectations of economic growth and inflation, the supply and demand of US Treasury bonds, and fiscal policies. However, the impact of these factors takes a longer time to reflect, hence the higher volatility in long-term interest rates, while short-term bonds demonstrate higher stability.
High yield bonds: high returns and diversified investment tools.
The overall size of high yield bonds in the USA has increased from $338 billion in 2000 to $1.38 trillion as of December 2023, becoming a welcomed asset class for investors. In addition, according to the Intercontinental Exchange's BofA Merrill Lynch US High Yield Index, US high yield bonds account for about 62% of the global high yield bond market, covering multiple industries. The Allianz US Short Duration High Income Bond Fund holds high yield bonds with a maturity of less than 5 years. As of September 30, 2024, the fund's Class AM (USD) distributed shares have a return rate of 7.8% this year.
Overall, short duration high income bonds may provide an attractive option for investors seeking high returns. However, when considering incorporating them into their investment portfolios, investors must carefully evaluate the default risks and market volatility. Through in-depth analysis of market conditions and issuer fundamentals, investors can better grasp the opportunities and challenges brought by high yield bonds, thus formulating more reasonable and effective investment strategies. In this rapidly changing financial market, investors who can seize opportunities and manage risks properly can stand undefeated in the world of high yield bonds.
Convertible bonds are versatile in both offense and defense.
In addition to short duration bonds, investors may also consider another diversified asset - income and growth strategy. While the three major US stock indexes continue to reach new highs, the financial markets are ever-changing. Besides holding high yield bonds during rate-cutting cycles to stably collect interest income, stock investors can also deploy convertible bonds to hedge against the risk of stock market downturn. When the stock market declines, investors can continue to hold convertible bonds to earn sustained potential returns; when the stock market rises, investors can convert the convertible bonds into stocks to capture the potential for stock market growth, making it a versatile investment tool for offense and defense.
Due to the risks involving bonds and stocks, if interest rates rise, the value of convertible bonds may also decline, and some issuers of convertible bonds may have credit ratings lower than investment grade, resulting in higher risks than investment grade bonds. In addition, investors can also use covered call options - holding long positions in individual stocks while writing related call options to earn option premiums. In flat markets, earning option premiums may outperform the overall market in terms of portfolio returns. During bear markets, it can help offset some of the stock price declines, also providing the opportunity to outperform the overall market in terms of portfolio returns.
