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Bond Market Commentary

Yet another cost to waiting?

By Doug Drabik
November 13, 2017

There are many investors, traders and economists who are positioning themselves for rising interest rates. How do I know this? Because it is well documented. Each of the past several years, multiple surveys of experts dutifully predict that over the following year, interest rates will be significantly higher by year’s end than at the start of the year. It’s a “safe” prediction because each of these years have begun close to historical interest rate lows; therefore conclusively, there is but one direction for interest rates to go.

The years have passed and a paradox has ensued. The “certainty” of rising interest rates has instead persisted with lingering low interest rates. The FOMC, in December, 2015, launched the first or four rate hikes and has managed to lift short-term interest rates, but inflation, world interest rate disparity, central bank intervention and other forces have turned predicting interest rate direction into an apologetic sport. Since the beginning of 2014, the 5-year Treasury is relatively flat (+30bp) and the 10- and 30-year Treasury rates are down 64bp and 111bp respectively despite the four Fed hikes of 25bp each.

It is very easy to get drawn into the drama of forecasting yet distinguishing differences in bonds versus growth assets, permits much more latitude, mostly due to the predictability of an asset class (bonds) in an otherwise unpredictable economic world. Bonds deliver (barring default) what they declare to no matter what happens in the inexact economy and changing interest rate environment. From day one with a bond purchase, it delivers a known cash flow stream, predictable income and a set day when face value is returned to an investor… period!

So now we’re on the brink of a major potential change with the released tax reform proposal. The bill proposes terminating private activity bonds, repealing the use of advance refunding and tax credit bonds and prohibiting the sale of tax-exempts for professional sports stadiums. The bottom line is that if these municipal underwritings are no longer permissible, the municipal bond market could shrink by 20-30%. It is a long way from potentially becoming a reality, but if it were to pass, a shrinking municipal bond supply would likely provide a meaningful price push. Municipal bonds currently provide a relatively strong value in the 10-15 year range and therefore reason to be engaged in that market. With passage of this tax reform a possibility, it presents yet another reason why the cost of waiting may prove to be an expensive endeavor.

Look to this week’s release of the Fixed Income Quarterly which will touch on other ways to benefit in this interest rate environment. Keep in mind that bond strategy and purpose is rightly dissimilar to that of growth or total return asset acquisitions. Sureness in performance begins at inception and ends at maturity.


To learn more about the risks and rewards of investing in fixed income, please access the Securities Industry and Financial Markets Association’s “Learn More” section of investinginbonds.com, FINRA’s “Smart Bond Investing” section of finra.org, and the Municipal Securities Rulemaking Board’s (MSRB) Electronic Municipal Market Access System (EMMA) “Education Center” section of emma.msrb.org.

The author of this material is a Trader in the Fixed Income Department of Raymond James & Associates (RJA), and is not an Analyst. Any opinions expressed may differ from opinions expressed by other departments of RJA, including our Equity Research Department, and are subject to change without notice. The data and information contained herein was obtained from sources considered to be reliable, but RJA does not guarantee its accuracy and/or completeness. Neither the information nor any opinions expressed constitute a solicitation for the purchase or sale of any security referred to herein. This material may include analysis of sectors, securities and/or derivatives that RJA may have positions, long or short, held proprietarily. RJA or its affiliates may execute transactions which may not be consistent with the report’s conclusions. RJA may also have performed investment banking services for the issuers of such securities. Investors should discuss the risks inherent in bonds with their Raymond James Financial Advisor. Risks include, but are not limited to, changes in interest rates, liquidity, credit quality, volatility, and duration. Past performance is no assurance of future results.