Following the U.S. Federal Reserve hiking its benchmark interest rate 11 times since March 2022, U.S. Treasuries are offering among their highest yields in years and look particularly compelling from a risk/reward standpoint, says Fidelity Portfolio Manager Jeff Moore.
"Although we've historically looked to corporate bonds and other credit markets to add yield within the portfolio, these days we're particularly excited about the value opportunity we see in risk-free U.S. Treasury securities, given the combination of their relatively tight credit spreads and high income," explains Moore, who co-manages Fidelity® Advisor Tactical Bond Fund (FBAHX) and Fidelity® Advisor Investment Grade Bond Fund (FGBPX) with Michael Plage.
This multi-sector bond strategy, launched in early 2022, gives the managers flexibility to allocate across the full spectrum of the debt market, including investment-grade, high-yield, and leveraged loans, to take advantage of wherever they see opportunity.
Given the favorable risk/reward opportunity present in U.S. Treasuries these days, Moore explains that they have recently been capitalizing on bouts of volatility in that market, while de-emphasizing corporate bonds, which they consider less attractive, based on tight credit spreads.
Moore points out that the Treasury yield curve remains inverted, meaning that yields on short-term bonds are higher than their long-term counterparts, a direct reflection of the Fed's aggressive campaign to hike rates to cool the economy and bring down high inflation.
He clarifies, however, that historically the yield curve hasn't stayed inverted for long. That's because investors typically demand more income in exchange for taking on more duration (interest rate) risk. Still, Moore feels a changing yield curve may present an upcoming investment opportunity.
One way the inverted yield curve could move to a typical, positively sloped one, Moore contends, would be if the economy experienced a hard landing, typically characterized by an uptick in unemployment and mounting investor fear of a recession, a situation he does expect at some point, though not necessarily in the near term.
Moore acknowledges that he and Plage may be a little early to the Treasury trade, but for good reason: "History has shown us that the yield curve has inverted gradually but steepened rapidly. Therefore, if a softening economy leads to a sudden steepening of the yield curve, we'll need to be early enough to avoid missing out on the market shift. Simply put, by the time market conditions start to reflect a new economic reality, it will most likely already be too late to take advantage of."
Against this backdrop, the co-managers have positioned the fund for the environment they anticipate, remaining patient as they await the opportunity to capture what they believe could be significant potential value.
"We're quite excited, particularly about prospects for the bond market and U.S. Treasuries, which represented about 44% of the portfolio as December 31, because we anticipate significant upside and limited downside, given where U.S. Treasury yields are these days," concludes Moore.