Where fixed income investors are finding yield as geopolitical risk rattles markets
As the Iran war shakes up markets, strategists say there are still plenty of sources of relatively safe yield for income-seeking investors – but they will have to be discerning. The major averages were on pace for sharp gains on Friday, with the S & P 500 on the verge of erasing its losses since the start of the Iran war. However, markets have been on a roller-coaster ride since the conflict began, with the broad market index down more than 9% from its high at one point. Higher oil prices have also spurred worries around inflation, spiking Treasury yields since the war started. Bond yields and prices have an inverse relationship. That means Treasurys were selling off as rates leapt. “Given what’s happening with inflation pressures moving higher, it’s been a little less exciting to leverage Treasurys as a flight to safety,” said Anders Persson, chief investment officer, head of global fixed income, at Nuveen. “Now with inflation risk at the forefront and you add in these fiscal risks, you can see this tricky environment where Treasurys and risk assets are selling off at the same time,” he added. Managing price volatility To handle the shakiness of the fixed income market, Persson stresses keeping credit quality high while also maintaining duration – a measurement of bonds’ sensitivity to interest rates – “short to neutral.” Bonds with longer maturities tend to have greater duration, so they will see the largest swings in prices when rates fluctuate. “We’re focusing on the belly of the [Treasury] curve, a little shorter than 10 [years] and a little longer than 2,” said Persson. Being near the “front to the belly” of the curve also leaves investors room to see how the Federal Reserve manages rate policy for the rest of the year, according to Russ Brownback, deputy chief investment officer of global fixed income at BlackRock. “We think by the end of the year, assuming there is no longer open-endedness to the geopolitical conflict, we think the Fed will be able to deliver rate cuts,” he said, adding that his team sees “one or two” quarter-point cuts by year end. Fed funds futures trading suggests a 75% likelihood that the target rate range will still be 3.5% to 3.75% in December, according to the CME FedWatch tool . “We want to be in the front to the belly of the curve to get that repricing of Fed cuts, and we want to layer on corporate and securitized debt to get that yield,” Brownback added. He is keeping duration at about two to five or seven years. Seeking yield with an eye toward quality Asset classes that look promising amid geopolitical risk include municipal bonds, according to Persson of Nuveen. These bonds are also backed by the full faith and credit of the issuer, which generally makes them a safer bet compared to corporates. “We’re trying to be opportunistic across the rating spectrum,” Persson said, noting that the firm has done some digging in the below investment-grade muni space. “Given the geopolitical uncertainty, we’re finding [municipal bonds] to be insulated more broadly.” The kicker for muni bonds is their tax-free interest income, which is especially valuable to high income investors in high-tax states. “When you look at muni bonds for highly taxed investors, the valuations are relatively compelling and so is the absolute tax equivalent yield,” said Bill Merz, head of capital markets research at U.S. Bank. Corporates can also offer solid opportunities for discerning investors. “Investment grade corporates are at yield levels we haven’t seen since the tariff tantrum in markets last year,” said Matt Wrzesniewsky, head of fixed income client portfolio management at Vanguard. There are opportunities to scoop up issues yielding 5%, he noted. In riskier, yield-rich corners of the market, like leveraged loans and bank loans, investors ought to proceed with caution — or at least leave the selection to the pros. Artificial intelligence disruption fears have put software companies under pressure – and those companies tend to be big borrowers from private lenders. This shakeup has led to a wave of investor withdrawals from private credit funds. “The leveraged loan space has a meaningful exposure to software,” said Nuveen’s Persson. “Be mindful of the headwinds that AI has been presenting for the credit space.” Focus on long-term goals It may be tempting to flee to cash when fixed income markets are in turmoil, but that would be a mistake, said Wrzesniewsky. “Panicking and parking money in cash is not a very sound strategy, and you’re likely to underperform opportunities further out on the curve,” he said. Instead, investors ought to ensure their fixed income allocation reflects their goals and risk appetite. “If you have a long time horizon, stick to your strategy,” Wrzesniewsky said. “The market is creating pockets of value.”