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Fixed Income Sector Review

By Brian Schaff
 
Every day there seems to be a new headline pointing out how far we’ve come in the interest rate cycle. At a range of 5.25%-5.50%, the Federal Funds Rate is at its highest level in twenty-two years causing mortgage rates, credit card rates and essentially all forms of borrowing to be as well. Just last week, a new issue Agency bond printed with a 7% coupon at par. With two Federal Open Market Committee meetings remaining on the calendar this year, there’s some speculation that there could be another rate hike in store. But my question is: whether there’s another rate hike from the Fed or not, what does your gut tell you about where we are in the interest rate cycle?

September alone was a wild ride for the Treasury curve. In the chart below, the green line shows the Treasury curve as of September 27th, while the yellow line represents rates at the start of the month.
 

 
Despite tightened liquidity, bankers are focusing on reviewing investment strategy right now before the end of the year. Taking a macro approach, it’s important to remember the role a bond portfolio plays in a bank. In addition to providing supplemental income on excess cash, fixed income investments can be crucial in an economic downturn. Recessionary events lead to increased loan charge-offs, and falling rates create gains in bonds that can offer relief given they are purchased at the potential high end of the cycle.

If these problems and their solutions sound familiar, it may be a good time to think about where to find value in the market. Each fixed income sector has benefits and drawbacks, and as markets shift, so should your approach to each sector.
 
  • Treasuries- Severely inverted yield curve that has lasted the entirety of 2023. Best used as a laddered liquidity vehicle.
  • Certificates of Deposit- Influx of issuers has pushed yields up, and they can offer meaningful spread over comparable Treasuries. FDIC insured, but only up to $250,000. Depending on bond accounting practices, no mark to market and no unrealized loss as a result.
  • Agency Callables- Prioritize yield lockout and limited issuer optionality with call types. Deep discount, low coupon bonds printed during lower rate environments can act as bullet alternatives with better spread to Treasuries.

  • Mortgage Backed Securities- Monthly principal and interest provide cash flow and have excellent liquidity with TBA eligibility. Current coupon pools face risk of quicker repayment, but discount to par prices help alleviate in the event of falling rates.

  • Municipals- Curve not inverted like Treasuries past about five years, resulting in yield compensation further out on the curve. Rising cost of funds has made bank qualified bonds more attractive than general market bonds due to effect on the TEFRA penalty. Like Agency callables, longer call dates ensures yield stays on the books.
Understanding the role of the bond portfolio through different economic environments allows for its true benefits to take shape. Unrealized losses have mounted over the past 18 months, but failing to dollar cost average after historic rate increases risks only “buying low and selling high”. Please contact your Country Club Bank representative if you’d like to discuss an investment strategy that works best for you.
 


This information is intended for institutional investors only. The material provided in this document/presentation is for informational purposes only and is intended solely for private use. Past performance is not indicative of future results. This material is not intended as an offer or solicitation for the purchase or sale of any financial instruments.

•Not FDIC Insured •No Bank Guarantee •May Lose Value