"Don't Pick Up Nickels in Front of a Steamroller:" Warning for Fixed Income Investors

Sam (0:00)

Welcome back to Morning Trade Live. It's time now for the Big Picture. Let's welcome in Cooper Howard, Director of Fixed Income Research and Strategy, Schwab Center for Financial Research. Good morning to you, Cooper. Hope you had a nice weekend. What's your outlook for the week?

Cooper Howard (0:12)

Morning, Sam. I hope you had a nice weekend too.

If you look at kind of the week ahead, I do think that it's going to be a light week in terms of economic data. Obviously, we get the Fed meeting minutes on Wednesday, so I think that that's gonna be important in terms of kind of the big event this week. I think it'll shed a little bit of light under the surface of ultimately what led the Fed to hike interest rates. And I wouldn't be expecting too much in terms of that. So we all know that they're very focused on the inflation front, and they're just seeing it run a little too hot and continue to remain too hot for an extended period of time. If you just look at PCE or CPI, it's been running above the Fed's target for five plus years now. So I do think that that obviously is a concern. So in terms of what will probably come out of the Fed minutes, I think that that's going to be important.

But also more importantly would be any potential about further rate guidance. So in our expectations right now, Sam, we do expect that the Fed's going to hike at least one more time this year, potentially into next year. But I do think it really boils down to the breadth as well as the pace of inflation. So we saw last week that it's not moving in the right direction, and also the breadth isn't necessarily there. So I think that that's going to be important for going forward.

Sam (1:25)

Yeah. And as we can see here, according to CME FedWatch, I mean, a lot of the pricing in has been sort of backed out until December now for that rate hike, have gone down to 21.6 percent for an October possibility here. So as far as what you're saying to clients right now, I mean, you and I discussed last week, you wouldn't suggest extending duration just yet. I mean, how high do you see yields going in this environment when you have a lot of talk around obviously nominal GDP running at eight and a half percent? So there is some expectation. We could see some further upside from here.

Cooper Howard (2:03)

Yeah, so I think that what is important to break down is fundamental factors of why yields are moving a little bit higher versus the momentum side of things. And if we look at the fundamental factors, you and I have spoken about this before, but we like to break it down into fed funds expectations, excuse me. It's a Monday morning here, as well as inflation expectations, as well as the term premium. And if you look at those fed funds expectations, those like you'd mentioned have been backing off a little bit. So those fundamental factors are starting to slow a little bit. However, the momentum side of things is still there. So we don't think that it's really an opportune time to try to add duration into your portfolio just because it's really akin to trying to pick up nickels in front of a steamroller at this point. It's not to say that we would not be too favorable on fixed income in this environment. We do think that there are opportunities within the fixed income environment because of where absolute yields are. And that really bodes well for longer term income-oriented investors, as well as investors who are more focused on a total return mentality.

Sam (3:08)

Okay, let's talk about some of those opportunities because you've highlighted muni bonds. You and I have spoken about that before.

They did have a tough September, but I was looking at the flow of funds and some of BFA's charts on Friday for the week and muni bonds had their biggest inflow ever at $4.2 billion. Just break down what's going on there.

Cooper Howard (3:31)

Yeah, so it's been a very difficult month for munis in September, and they actually declined over about 5%, which is a pretty bad month for the market overall. But really what that's led to is it's led to valuations as well as yields to be at fairly attractive levels in our view, Sam. If you just look at the Bloomberg Municipal Bond Index, that's at levels that we haven't seen in about the past two decades. So we do think that that's a pretty attractive point to consider municipal bonds. Also, another thing that we like to look at is the muni to treasury ratio. That's really just a metric that compares the yield on a AAA-rated municipal bond to that of a treasury. And right now, that's north of 70%. That got all the way up to as high as 80%.