My name is Don Ellenberger. I'm Head of Multi-Sector Strategies at Federated Hermes.
In the era of COVID, why own corporate bonds?
There are really two reasons to own corporate bonds. The first is the Fed. For the first time in history, the Fed has begun buying individual corporate bonds and corporate bond ETFs including so-called fallen angels, bonds have been downgraded from investment grade to high yield. The Fed can do this because they have a super power, no other institution on earth has. They can create an infinite amount of dollars, literally out of thin air. And they're doing that to buy corporates and other bonds to maintain liquidity in the bond market and to tighten spreads, which lowers borrowing costs for companies and helps to support economic growth. And the worse the economy gets, the more the Fed will buy, acting like an automatic stabilizer on the economy and the markets.
So with the Fed removing the fat tail risk of significant spread widening, corporate bonds should continue to outperform their government counterparts. It also helps that the bar to outperform government bonds is so low right now. The yield on the treasury bond index which is an average of all bonds between one and 30 years is right now at a record low of only 0.4%. So, there's almost no income and very little upside for treasuries unless you think rates in the U.S. will turn negative, but the Fed is in no hurry to take rates negative because that would hurt bank revenue, it would crush money market funds and it just really hasn't worked all that well in Europe or Japan where rates have been negative for several years. And while it's true that the duration of the corporate bond index is at an all time high, interest rate risk isn't as bad as it appears because the Fed simply won't permit rates to rise a lot since that would hurt economic growth and the recovery that the Fed and Congress are trying to engineer.
In addition to the Fed, what other reasons are there to own corporate bonds?
Another reasons to like corporate bonds is that there is a mountain of cash sitting on the sidelines just looking for a home. Money supply is growing at a staggering 24% annualized pace. That's the fastest since 1942. 2.6 trillion in dollars poured into money market funds and bank deposits just in the first half of this year. That's dead money with a guaranteed return of nothing over the next two or three years. So, as greed starts to overtake virus fears and investors become more and more desperate for yield, we think that cash will get put to work and credit spreads will grind tighter for the simple reason that you just can't live on 0% forever.
Disclosure: Views are as of 8-6-2020 and are subject to change based on market conditions and other factors. These views should not be construed as a recommendation for any specific security or sector. Bond prices are sensitive to changes in interest rates, and a rise in interest rates can cause a decline in their prices. The spread is the difference between the yield of a security versus the yield of a U.S. Treasury security with a comparable average life. Duration is a measure of a security's price sensitivity to changes in interest rates. Securities with longer durations are more sensitive to changes in interest rates than securities of shorter durations. Unlike corporate bonds, government bonds are guaranteed as to the payment of principal and interest. High-yield, lower-rated securities generally entail greater market, credit/default and liquidity risks, and may be more volatile than investment grade securities. Money market securities offer relative safety and stability compared to longer term debt instruments. Bank accounts, unlike bonds, are FDIC insured and offer stable principal. Federated Investment Management Company, 20-30358 (8/20)