The Complex State Of Fixed Income

Low rates, inflation and COVID are making the asset class a tough part of the portfolio to manage.

Reviewed by: Dan Mika
Edited by: Dan Mika

Joe Boyle​Bond buyers are facing a triple threat of uncertainty heading into 2022. The Federal Reserve has already signaled the end of corporate bond-buying and an interest rate hike, but inflation and COVID’s possible resurgence in the Omicron variant are issues as well.

Joe Boyle, fixed income product manager at Hartford Funds, lays out where he sees opportunities and weak points heading into the new year. The current state of fixed income is extremely complex. We have inflation worries, we have the Federal Reserve's plans for tapering bond buying and increasing rates, and on top of those, we have the Omicron variant of COVID that's generating volatility across the market. How complex is the situation right now on the fixed income side in the waning stages of 2021 and heading into 2022?

Boyle: It’s been very difficult for investors. The question we're getting a lot is, how do I handle my fixed income allocation? Because rates are still historically low and spreads are tight, making valuations rich. This is across basically all fixed income sectors. And then you have this inflation question that everyone's struggling with.

What we try to bring it back to is, what do you own fixed income for? The opportunity for total return isn't really there right now in the environment. But you own fixed income as an offset to your equity allocation, and we try and have our investors keep that in mind, that you want this when we have a risk-off situation. You wanted it there two Fridays ago [on Thanksgiving] when the Omicron news broke and everyone was on vacation. You wanted to have some safety in your portfolio.

We know it's tough going forward. We know it's hard to find significant total return in fixed income. But you've really got to keep in mind what you own it for—and that's the ballast in your portfolio. Let's focus on what we're hearing out of the Fed with the current state of the taper, when they want to lift off on interest rates and how many times they may do it in 2022. How much of that is going into your thinking right now as to how you want to allocate in fixed income?

Boyle: You always have to pay attention to what the Fed is saying. Central banks across the globe have had such an impact on fixed income for the past 10 years that you really have to pay attention to what they're telling you. Powell's comments last week really had everyone stand up and listen. You have to take Powell at his word. He's been very direct and very transparent since he's been appointed.

The fact that he's removed “transitory” from his language, the fact that he suggests that we should perhaps be tapering faster, the market really stood up and listened and drew forward their expectations of a taper [ending] toward mid-2022 now.

You really can't hike rates until you're done tapering asset purchases. The fact that the current schedule says June to end bond purchases really means there's not liftoff until June.

Now, again, Powell's been very transparent. He telegraphs all this to the market during all his speeches. It seems he has all his governors do the same thing. And he hinted that they're perhaps going to adjust their taper purchases and then perhaps going to announce that next week at the FOMC meeting.

The issue is that we're always one headline away from pushing that back up to December 2022, right? So that was the Omicron variant. We were, prior to the Friday of Thanksgiving, also looking at the mid-2022 hike. That news [on Omicron] broke. The futures market pushed it back out to December 2022. People are less worried about the Omicron variant perhaps. They're still uncertain about it. But with Powell's comments last week, I really think the potential for a rate hike is now coming mid-2022.

We're by and large recommending staying shorter duration for the most part—not entirely short. Again, it comes back to the question of, what do you own fixed income for? Duration will be your friend in the times of risk-off environment. And we're definitely not out of the woods of COVID yet. We definitely still have a lot of uncertainty surrounding COVID, surrounding slowing global growth because we can't figure out these supply chain disruptions.

We would not recommend going all the way short. We recommend shortening up somewhat, and definitely adding or trying to maintain high quality.

The Fed should be supportive. The fundamentals are strong for growth. The economic backdrop is still in recovery, which should give a lift to markets that are struggling. Nevertheless, this is your fixed income allocation, so always maintain some sort of high quality, and then allocate tactically accordingly. Zooming out from the Fed and the Treasuries market, where else are you looking in terms of corporates, munis, non-U.S. government bonds? Where are you seeing potential winners and losers heading in to the next year?

Boyle: Floating-rate assets should do well, especially floating-rate assets with some credit to it. So that's the bank loans, leveraged loan market. They don't suffer from any interest rate risk. And if you think the fundamental backdrop is strong and supported, credit should do well.

Those assets already have a spread advantage over investment-grade corporates over some of the higher quality securitized assets. You should get a relatively better coupon and remove the interest rate risk, and that's with a strong economic backdrop.

In addition, emerging markets are really suffering this year. The blended index is down over 10%, so there could be a snapback in that market, especially on the corporate side. We look at a lot of emerging market corporates that, while they're domiciled there in the end, the majority of their business takes place in developed markets.

So while EM as a sector is suffering and they kind of suffer in sympathy, the markets they operate in are strong. They have a potential for significant snapback. It's just a matter of what happens with the dollar. The bonds themselves should be good, but the dollar's up over 7% this year and it's really caused the emerging market pain; hence the whole sector being down significantly, depending on which index you look at.

Contact Dan Mika at [email protected], and follow him on Twitter

Dan Mika is a reporter for He has previously covered business for the Ames Tribune and Cedar Rapids Gazette in Iowa, and BizWest Media in Fort Collins, Colorado. Dan holds a bachelor's degree in journalism from Truman State University.