Fed Rate Inaction Puts Spotlight on Bond ETFs

Fed Rate Inaction Puts Spotlight on Bond ETFs

JAAA, FLTR may be ETFs to consider as financial advisors adjust to likelihood of fewer rates cuts in 2024.

Wealth Management Editor
Reviewed by: etf.com Staff
Edited by: Ron Day

While stocks have recovered from the shock delivered earlier this week when inflation numbers came in higher than expected, financial advisors are scrambling to get fixed income strategies up to speed.

The bond market was caught flatfooted by the numbers, since it was anticipating as many as seven interest rate cuts this year, according to advisors and market watchers. Even though Federal Reserve Chairman Jerome Powell was all but broadcasting a much-less aggressive rate-cut strategy, the bond market clung to what it wanted until it didn’t make sense.

“As soon as the Fed went from projecting one to three rate cuts in 2024, the bond market expected there to be as many as seven cuts, based on Fed fund futures,” said Phil Kosmala, co-founder and managing partner of Taiko, an outsourced CIO firm for advisors and institutional investors.

“The bond market got way ahead of the Fed even though the Fed started backtracking in January,” he added.

JAAA, FLTR: Advising Around Fed Inaction

Kosmala sees multiple reasons to trust the Fed’s signaling.

“The strength of the economy, plus economic data, is forcing the bond market to get closer to the Fed’s expectations,” he said. “Our advice to our clients is pretty simple; the Fed will be delayed in cutting because GDP is still too strong, the labor market is strong, and inflation is nowhere near the Fed’s target.”

Kosmala said as long as investors are able to earn more than 5% sitting in cash and more than 6% in floating-rate investment grade securities, he doesn’t see a case for jumping into the 10-year Treasury at 4.24%.

“We’re telling clients to start extending duration when the 10-year gets close to 4.5%,” he added.

In the meantime, Kosmala likes the Janus Henderson AAA CLO ETF (JAAA) for its 6.8% yield and the VanEck IG Floating Rate ETF (FLTR) for its shorter-duration.

“As the yield curve stays inverted, clients should stay short duration and just clip the coupon,” he said.

Ryan Salah, a partner at Capital Financial Partners, has also called out the bond market for being wrong about the Fed’s near-term monetary strategy.

“You're starting to hear more talk about a scenario where inflation doesn't get to the Fed's target and stays elevated,” he said. “Whether this happens or not, it's important to maintain good diversification within fixed income between short, intermediate and long-term debt.”

Salah is expecting the Fed to start cutting rates at some point this year, “but not as early as people think.”

For Paul Schatz, president of Heritage Capital, the current bond market presents neither “great opportunity,” nor “imminent doom.”

“I don’t think the landscape changed much; I think the pundits got it wrong and are now revising history and trying to avoid yet another round of egg on their faces,” he said. “Our forecast was for a maximum of four rate cuts in 2024 with the risk being less unless there was some exogenous event which I am not smart enough to predict.”

In terms of his fixed income strategy, Schatz said, “I was buying, I am buying, and I plan to still buy short-term paper to take advantage of the inverted yield curve, and I will extend duration on mini spikes in yields.”

Jeff Benjamin is the wealth management editor at etf.com, responsible for coverage related to the financial planning industry. This includes writing, hosting podcasts, webinars, video interviews and presenting at in-person events.

Jeff is a veteran journalist with more than 30 years’ experience covering the financial markets. He has won more than two dozen national and regional awards for his reporting. He most recently worked as a senior columnist at InvestmentNews where he wrote about investment products and strategies, as well as the broader financial planning industry. Prior to that, Jeff worked as an analyst at Cerulli Associates where he researched and wrote reports on the alternative investments industry. Jeff also worked as a money management reporter at Dow Jones Newswires, where he covered the mutual fund industry.

Based in North Carolina, Jeff is a former Marine and has a bachelor’s degree in journalism from Central Michigan University.