Could high-yield bond funds the place to be now? There seems to be growing concern that growth is slowing worldwide, with Europe sluggish and high oil prices curbing growth everywhere. This would lead to worldwide lower interest rates, which should make high yield bond funds attractive. How does this impact the US, my primary economy of interest?
If US growth slows (and inflation remains low), Fed might have to pause the interest rate hikes soon (currently fed funds rate is at 3%, and futures indicate a 2005 year end rate of 3.5%-3.75%), and maybe start cutting interest rates again. This should be very positive for the bond funds. However, Fed might not pause the hikes, if inflation creeps up, which it might as oil is now at $60 (vs around $52 when the last inflation numbers came out).
The 10-yr bond is yielding 3.94% today. Is this the time to jump in, or should I wait it to rise to maybe 4.3% before I jump in? If the Fed actually hints at pausing in its rate tightening cycle in the next FOMC meeting in the next 2 days, that would be a boost to the high-yield bonds. On the other hand, that would lead to another boom in the housing market. If there is any blow up there, it might cause the risk-appetite to go down, leading to widening of spreads for everything, including high-yield bonds. So even if Fed funds rate gets cut, high yield bond yields might go up, simply because the spreads (between high yield and treasuries) are so narrow today. Then also, if economic growth slows and corporate cash flows dry up, companies might have a difficult time servicing the high interest coupons on their junk bonds. So this is a very tricky question, to which I have no answer.
There were some equity bulls out there who were happy with the prospect that interest rates hikes would pause. What I don’t understand is that why would equity markets go up if the pause is happening because growth is slowing? What I think should happen is that stock market would drift down as interest rates are cut because of slowing growth, and shoot up only when there is evidence that these interest rate cuts have started invigorating the economy. In the current bull market, the stock market took off only when the Fed funds rate was pushed down to historic lows of 1%. So maybe, it would make sense to wait outside the lines during the first few cuts, and jump in when it seems that the money-easing cycle is nearing its end.
Of course I am assuming here that growth is slowing in the US. It might not, and the second half might be much stronger than expectations, in which equity markets would rally. But I think it is safe to remain on the sidelines in the equity markets right now. This bull market has already outlasted most others in terms of duration.