Last week, remarks from several Federal Reserve officials conveyed that the US central bank is “getting closer” to the point of cutting interest rates.
According to Darryl Bruce, executive director of capital markets at Income Asset Management, corporate bonds have begun to perform well as the market prices in the expected rate cuts at the Fed’s September meeting. This will offer investors income and the opportunity for capital gain when the Fed starts to lower rates.
“It looks like the US might be on the cusp of interest rate cuts in September, with an 85–90 per cent chance of a rate cut priced in from the Fed that month. Being at the top of the interest-rate cycle, it is likely that money going into the fixed income markets now will reward investors over the coming years as rates move lower,” he explained.
Bruce believes that now is a good time to be investing in the corporate bond market, with yields sitting relatively high above 6 per cent on investment grade bonds.
“We are seeing strong demand for new bond issues. We’ve come from an environment a few years ago where yields were much lower and now, in the investment grade part of the market, we’re seeing yields of 6 per cent-plus. That is driving a lot of investor interest.”
The executive director gave the example of Spanish bank giant Santander, which recently issued $600 million of bonds in Australia.
“We’re talking to clients and one consistent message we give is to look at where yields are now. Using the Santander issue as an example, if you can lock in a coupon of 6.5 per cent for the next five years from an institution of Santander’s quality, that’s 6.5 per cent return per annum for the next five years from a defensive asset in your portfolio,” he said.
“That’s a good outcome, and it is clear that money going into the bond market right now will reward investors over the coming years. That’s the story that we’re talking about to investors.”
Moreover, Bruce is seeing healthy outcomes for carefully selected private credit assets. These historically provide an illiquidity premium over corporate bonds.
“In the higher yield loan environment, we see some great opportunities in the private credit market, and we’ll continue to access that market. Investors are picking up an extra 3 per cent or so return for going into some private credit assets compared to bonds, over a three-year period. Liquidity is a bit less of an issue for a three-year period so the payoff is attractive.”
