Fixed Income Finally Pays as Investors Rebalance From Equities

Sam (0:01)

Joining us now is Kevin Nicholson, Global Fixed Income, CIO Riverfront Investment Group. Kevin, thanks so much for joining us. Really appreciate your time today. So the bond market is really stealing the show at the moment. So from what you're seeing, how is that changing the way that investors are thinking about allocation?

Kevin Nicholson (0:19)

Thank you, Sam, good morning. I think that right now, because yields are above that 5% threshold, clients who have spent the last 15 years really just primarily investing in equities are now starting to think about, hey, we need to move more to fixed income because it actually will help de-risk our portfolio.

It will also keep our equities from having to do as much work. Because let's face it, getting a 5% plus yield right now and fixed income actually is attractive.

Sam (0:56)

Yeah. And where are you seeing the most demand and appetite across the curve?

Kevin Nicholson (1:01)

Well, right now, I think that people are still staying closer to the front end of the curve because you can almost get 5% right at the two-year. But there are some that are dipping their toe further out on the curve. I know for us, we recently neutralized our duration relative to the benchmark. And that was really based upon yields crossing over that 5% threshold.

That being said, I don't think that you should be making a duration plague right now because I think that there will be continued upside pressure on yields as long as we continue to have the Iran War go on and not have a solution or conclusion to it.

Sam (1:50)

Interesting. I was listening to the folks over at Charles Schwab and the podcast they put out over the weekend. And Colin Martin from the Fixed Income Team was actually making the point that the 10-year typically peaks around the final hike of a cycle rather than the first hike. So what is your outlook for the trajectory of rates?

Kevin Nicholson (2:08)

Well, I think that if we don't have a resolution to the war by midterms, I think that we could see the 10-year go to 5.5%. However, by year end, however, if we see a resolution, I think that the 10-year will move back to that 4.75% to 5% range.

Sam (2:30)

Okay. What are you seeing as far as the appetite right now for sovereign debt compared to corporate issuance, which seems to be giving the former a bit of a run for its money?

Kevin Nicholson (2:42)

Yeah. I think for me right now, I think it's important to really switch from taking on so much credit risk and take a little bit more interest rate risk. And the reason I say that is because credit is so tight right now, and you're really not getting paid to go into credit, where now I think that interest rate risk is actually, you're starting to finally get paid for it. And that's why I would say folks are gradually dipping their toe into extending out on the yield curve from a duration standpoint.

Sam (3:18)

Then the 640 portfolio is alive and well right now?

Kevin Nicholson (3:24)

Yes, I think so. I mean, obviously, the fixed income returns aren't great at the moment. But I think that it's about your entry point. And when you're entering a portfolio or an investment north of 5%, then the income generation is going to outstrip the price depreciation over time. And I think that that's an important theme for folks to remember because a lot of folks did not want to invest in fixed income because they have memories of 2022

But you were coming off such a lower base starting point as far as bond yields at that point. So now I think that with yields higher, it gives investors an opportunity to have a better blend in their portfolio between the equity and bonds.

Sam (4:20)

Which data prints are you going to be looking at the closest this week, given of course it's such a busy one as far as top tier economic data, which no doubt goes into the Fed's calculus here being obviously the PCE. That's the Fed's preferred gauge of inflation.

Kevin Nicholson (4:38)

Of course, we will focus on PCE because that is top of mind. With the Fed right now, Chairman Warsh has stated that he needs to get inflation under control. And so that is going to be the number one item that we look at. But I will say that the labor market is really important because as long as the labor market can continue to be solid, that allows A, the equity market to continue to grind higher, and B, it allows the Fed to be able to actually attack and get inflation under control.