T-bills were all the rage last year, as their yields rose alongside surging interest rates. But yields have tapered off in recent months amid expectations that we’re nearing the end of global interest rate hikes.
With the US Fed recently hinting at a possible pause, yields on T-bills – while still attractive – are unlikely to revisit their record highs again.
Now could be a good time to consider investment-grade corporate bonds to lock in today’s high yields for at least the next few years.
US interest rates are peaking and could soon fall
As expected, the Fed raised interest rates by another 0.25% this week. But notably, they omitted the line saying they anticipate more hikes may be appropriate, suggesting a possible pause in the rate hiking cycle.
Although Fed Chair Jerome Powell insisted it was too soon to bring interest rates down, markets heard differently. Based on US interest rate futures, traders are betting that rate cuts could come as soon as September.
Of course, the actual outcome will depend on how much more inflation improves from here, and whether the US is falling into a recession.
In any case, history suggests that the Fed usually doesn’t wait too long to start cutting. The average time between the last rate hike cycle and the first rate cut has historically been about 6 months. If May’s interest rate hike is indeed the last in the current cycle, we could see a rate cut before the year is out.
But even if rate cuts don’t happen, it is unlikely that interest rates will continue rising as they have been. The more the Fed hikes, the greater the risk that the US will be tipped into a recession. The latest data already shows that US economic growth slowed in the first quarter of 2023, growing at an annual rate of 1.1% versus 2.6% in Q4 2022.
What this means for investors
In a nutshell, here are 3 scenarios I think could happen:
- No more rate hikes; Fed holds interest rate steady for the rest of the year, starts cutting in 2024
- Fed starts cutting interest rates this year
- Inflation suddenly surges; Fed hikes rates 1 -2 more times (quite unlikely at this juncture)
Based on scenarios 1 and 2, the era of multiple interest rate hikes has come to an end. With that, the upward momentum for T-bill yields has also stalled.
If we still want to enjoy attractive yields months or years from now, it is time to start locking them in using bonds with longer maturities.
Why lock in yields
Consider this: A 5-year bond yielding 4% would offer you 4% every year for 5 years.
But with a 6-month T-bill, there’s no guarantee you can reinvest at the same yield once it matures. In fact, it is more likely that you will have to reinvest at a lower yield as interest rates begin to go down either year-end or early next year.
This reinvestment risk is a huge reason why I think investors shouldn’t put too much of their money in short-term T-bills right now, and why bonds with a longer duration are looking more appealing instead.
Plus, I think bonds just make sense in the current macroenvironment.
Look beyond Singapore Savings Bonds
For investors who want the safety of guaranteed albeit lower returns, Singapore Savings Bonds (SSB) are a good option to lock in yields for 10 years.
But honestly, June’s SSB tranche at a 10-year average return of 2.81% isn’t that appealing.
If you’re willing to take slightly more risk to achieve relatively higher yields, investment-grade corporate bonds could provide some yield pick-up over Singapore government bonds.
What are investment-grade bonds?
While not risk-free, investment-grade (IG) bonds tend to be less risky than their non-IG counterparts. The term IG refers to corporate bonds that are rated BBB and above by Standard & Poor’s (S&P) and Fitch.
IG bonds are deemed to have a lower risk of default. In fact, the average default rate for IG bonds has historically been below 1%. So even in times of economic uncertainty, IG bonds tend not to default and cause bondholders to lose all or part of their initial investment.
How to invest in investment-grade bonds
Investors can get exposure to IG bonds by buying either individual bonds or bond mutual funds / ETFs.
However, a fund is usually the more convenient way to get diversified bond exposure without spending a fortune. While it is possible to buy a single stock with $1 nowadays, most corporate bonds require a minimum investment of S$200,000!
And when it comes to fees, ETFs are typically cheaper than mutual funds.
For Singapore investors, the Nikko AM SGD Investment Grade Corporate Bond ETF (MBH) is a low risk bond fund that offers yields more attractive than T-bills.
|ETF||Weighted average yield to maturity (YTM)*||Weighted average duration||Average credit rating||Distribution frequency||Total expense ratio||Description|
|Nikko AM SGD Investment Grade Corporate Bond ETF (MBH)||4.48%||6.05 years||A||Semi-annual||0.26%||Invests in Singapore Dollar denominated IG corporate bonds|
Since it is SGD denominated, it has no currency risk for Singapore investors. The top 5 issuers are also established local institutions such as DBS Bank, Temasek Financial and United Overseas Bank (UOB).
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Disclaimer: Not investment advice. This article should not be construed as a solicitation or an offer to buy or sell any securities or related financial instruments. Always do your own research before making any investment decisions!