Charles Schwab Fixed-income Strategist Collin Martin discusses the bond market and what to expect with Treasury yields ahead of the Fed's policy decision.
ALEXIS CHRISTOFOROUS: All right, I want to bring in Collin Martin now. He is fixed income strategist at Schwab to talk a little bond market. Collin, good to have you here. I guess no surprise to see that investors when they're fleeing riskier assets like the stock market, they're piling into the relative safety of the treasury market. Just talk to us a little bit about the action you're seeing in the treasury market today and what your expectations are for the Federal Reserve later this week.
COLIN MARTIN: Well, we're seeing exactly what you mentioned we'd expect in these types of days when stocks and risk assets are falling. We're seeing a bid for high quality treasury securities. The 10 year treasury yield is down sharply from the highs we saw last week getting back down to the 1.7% area, which again, makes sense when there are risks out there. The risks that have been beginning to price into the market lately have been the prospect of fed tightening. And when you throw these geopolitical risks into the equation, that gets investors a little skittish.
However, we're not seeing too much of a repricing just yet in terms of the outlook for the Federal Reserve. Expectations for the number of hikes have come down a little bit. But when we look at the fed funds futures market, they're still pricing in close to four hikes for most of this year. Again, it's very early right now. We're not expecting a hike this week. We do think there should be a hike at the March meeting. But when we look at what the outlook is for the rest of the year, the markets might have been a little bit too aggressive. They might have gotten a little bit ahead of themselves.
And we're more in the three hikes in 2022 camp.
- And for the first three weeks of the year, it really seemed that bonds were rattling the equity market. But the last couple of sessions, that seems to have flipped. Is that just something temporary? Do we see yields continue to rise? And then if so, the 10-year is at 1.72 at the moment. When do you see it touching 2%?
COLLIN MARTIN: We do think it should continue to rise, or rather resume the upward trend. But we don't see too much upside in the 10 year treasury yield. Coming into this year, we thought it could trade in the range of 1.75% to 2%. And we hit that range pretty quickly, although now, we're back sort of in the middle of that range. We do think it should move higher. But it really comes down to how quickly and how aggressive the fed is with its pace of rate hikes. If the fed feels the need to act too aggressively, and it hikes too quickly, that can really slow down growth expectations, which have already come down a little bit lately.
And then ultimately, that means where they end up, the fed's terminal rate, how high they can get its fed funds rate won't be too high. So that limits the upside of the 10 year treasury yield. Likewise, if they can actually take a patient approach, not act as aggressively, and if they're able to bring the rate of inflation down while not disrupting the economic recovery that we're currently in, that can allow them to actually get to a higher fed funds rate, hopefully above 2%.
In that instance, we can see the 10 year treasury yield move a little bit higher. For now though, we think we're probably going to be stuck in this 1 and 3/4% to 2% range with a little upside. But we need to get a better read on the fed's pacing, and timing, and really what their plans are for the balance sheet before we revise higher our outlook for the long term treasury yields.
ALEXIS CHRISTOFOROUS: Collin, I'm curious where you're seeing people concentrate their attention right now within the bond market. Is it corporate bonds, muni bonds? Are they taking on a little more risk with some of the junk bonds? And also what about the duration of the treasuries that they're buying up?
COLLIN MARTIN: Yeah, so far, we're still seeing investors focus more on short term treasury yields. Now when we talk to our client base at Schwab, there tends to be more of a short term bias just because there is a risk, and a lot more interest rate risk, when you invest in longer maturity securities. So we are focusing on more a favoring of short duration investments today. If we do continue to see yields move higher, we'd suggest our clients and investors move a little bit further out and lock in higher yields.
But we're not suggesting that just yet. One area though where we are seeing some demand is investments with floating coupon rates, specifically the bank loan investment type. Those are risky investments. They're like high yield bonds. But they have floating coupon rates. They have a lot less interest rate sensitivity. And we have seen a lot of investor demand there to start the year because holding them can kind of offset the risk of higher yields with your portfolio. And they're one of the few investments so far in 2022 that have posted a positive total return to date.
- Bond investors have been hit really hard, particularly at the beginning of the year. So when does that start to moderate? And do things get easier from that perspective? Is it in the first half? Is it at the second half of the year? When do we see some moderation?
COLLIN MARTIN: We'll probably see more moderation in the second half of the year. What we hope is that we see a modest increase in rates. Because when you see a sharp rise, that's really what spooks investors. You look at your account. And if yields rise, the price of your bond investments fall. That's a cause for concern and it can cause investors to unfortunately unload some of their bond investments when in reality, as yields rise, it should be an opportunity to lock in those higher rates.
Ultimately, what we expect is a flatter yield curve, meaning we see a lot more upside with short term interest rates, as opposed to long term interest rates. But most importantly, we expect more volatility this year. So you need to be ready to ride out the ups and downs as the fed is moving from its very, very easy monetary policies to policies that are one, they're going to start as less easy and then eventually get to tight. That should just lead to a bit more volatility really for all types of investments.
So we think that's what's important for investors to focus on, but not necessarily panic if you are in high quality investments like treasuries or high quality munis or corporate bonds.
ALEXIS CHRISTOFOROUS: All right. Collin Martin, fixed Income strategist at Schwab. Thanks for your time today. We appreciate it.