Where to Fish for the Best Fixed Income Yields Today
By John H. Robinson, Financial Planner (Feb 25, 2024)
I will get straight to the point – there are just three types of investments I am recommending for the “safety and income” portions of client portfolios – U.S. Treasury money market mutual funds, brokered CDs, and government agency bonds.
Treasury Money Market Mutual Funds
With the yield curve still inverted (i.e., shorter maturity fixed income investments generally yield more than comparable longer maturities), many taxable money market funds are still yielding north of 5.0%. Although money market fund yields are variable, for the past two years, money market yields have compared favorably to bank deposits (including online banks) and have offered a safe liquid place to park cash. That continues to be the case.
Detractors often point out that money market funds are a form of mutual fund and are therefore not as safe as FDIC-insured deposits. Although technically true, as a matter of fact, only a few money market funds have ever broken the buck (i.e., failed to maintain the requisite $1.00 per share daily valuation), and those that failed were all “prime" money market funds that invested in very short-term corporate bonds. There has never been a treasury money market fund that has broken the buck, and it is difficult to envision any scenario in which short-term treasuries would ever default.
One additional advantage of investing in pure treasury money market funds (as opposed to government securities money market funds) is that the interest paid on the underlying treasuries is exempt from state income tax. This can provide a nice yield boost relative to taxable fixed-income investments in states with high state income tax rates (e.g., Hawaii, New York, Massachusetts, and California).
Brokered CDs
Interest rates on certificates of deposit have been on a bit of a roller coaster ride over the past few months. As I chronicled in a December FPH Blog post, mid-November 2023 marked a three-decade-long peak for short-intermediate term CDs. At that time, we were seeing 6-12 month brokered CD rates as high as 5.75%. For a couple of weeks, we were also able to get 5% on non-callable CDs as far out as five years.
The decline from that peak was surprisingly swift. By the end of January, investors could not get 5% on brokered CDs for any maturity beyond six months, with the top 12-month rate hovering around 4.75% while the 5-year yields retreated to the 4.2% range. Interest rates on CDs have since rebounded, though they are still well below the peaks set last November. I have consistently been recommending investors extend maturities as far as they can and still get at least 5.0%. As of this writing, we are seeing yields of 5% out only as far as 18 months. This is the same guidance I gave in my December 2, 2023 blog post.
It is worth mentioning that yields on FDIC-insured brokered CDs are still generally favorable relative to the rates consumers are seeing at their local banks and credit unions. The rates are also competitive against online banks. As I noted in another recent blog post, brokered CDs may also have certain structural advantages over traditional Bank CDs.
U.S. Government Agency Bonds
These consist of bonds issued by the Federal National Mortgage Association (FNMA), Federal Home Loan Mortgage Corp (FHLMC), Federal Home Loan Bank (FHLB), Federal Farm Credit Bank (FFCB), and Tennessee Valley Authority (TVA). Although the bonds are not FDIC-insured and are not backed by the full faith and credit of the U.S. Government, congress’ implicit obligation to keep these government-sponsored enterprises (GSEs) afloat affords them the same AA+ rating that has been assigned to U.S. treasuries.
READ: U.S. Agency Bonds: What You Should Know (Charles Schwab)
The attraction to agency securities in the current rate environment is that they may allow investors to get yields as much as .25% to 1.0% more than we can find on comparable CDs for maturities of 1 year or longer. A limitation of investing in agency securities is that they are typically callable. However, at this time, we are seeing yields of 5.4% and higher for agencies with 3-5-year maturities and at least 1 year of call protection. The yields to call and maturity are higher than what I am seeing on 1-5-year CDs. As long as the buyer can be flexible on when the bonds may be called or mature, agency bonds may offer attractive yields without much credit risk.
Further, agency bonds issued by FHLB, FFCB, and TVA all pay interest that is exempt from state income tax. This makes them particularly attractive in taxable investment accounts.
The Outlook for Interest Rates
The driver of the plunge in yields last November was the media’s and the public’s baffling interpretation of Federal Reserve Chairman’s comments at the Fed’s November and December Open Markets Committee meetings. In both of his press meetings, Mr. Powell indicated that the Fed was taking a wait-and-see approach on inflation and that it could not rule out future increases. Here was the media’s interpretation of those comments –
Fed Signals Three Rate Cuts in 2024, End of Higher Interest Rate Cycle (U.S. News, Dec 13, 2023)
Similarly, in its commentary following the December Fed Meeting, CNBC reported “After its December 2023 session, the Fed forecasted it would make three quarter-point cuts in 2024 to lower the benchmark rate to 4.6%.” I listened to Mr. Powell’s commentaries, and he did not say anything remotely along those lines on either the November or December calls. I encourage readers of this column to inspect the press releases below and see if you can find any mention of three (or even one) expected rate cuts.
FOMC Press Release 11/1/2023
FOMC Press Release 12/13/2023
I continue to be baffled by bond investors’ reactions to Powell’s commentaries. The man has no reason to lie. Ever since the days of Alan Greenspan, the Fed Chairmen have tried to be as clear and transparent as possible. When Mr. Powell suggests that the Fed has not yet even decided to stop raising rates, it would be wise to believe him. This unfortunate reality is beginning to set in with the wishful thinking crowd who have been hoping against hope that the fed was poised to cut rates three times in 2024.
The Fed Just Can’t Stop Bond Traders’ Wishful Thinking (Bloomberg, 8/22/2022)
Fixed-Income Outlook 2024: Bonds Roar Back! (Alliance Bernstein, 12/27/2023)
Market Expectation for six rate cuts (for 2024) is wishful thinking (CNBC, 2/20/2024)
My outlook is the same as it ever was – the yield curve will eventually revert to normal, but the driver will not be so much Fed short-term rate cuts as acceptance of the idea that longer-term rates will return to more historically normal (i.e., higher) levels. Short-term rate cuts may happen later this year (or they may not), but long-term treasury rates and mortgage rates probably should be higher.
One of my mantras that bears repeating is “Friends don’t let friends by bond mutual funds.” Rising long-term rates spells even more misery bond mutual funds, which is why I cringe when I see headlines like these –
This is a good time to invest in a bond fund (Morningstar, 12/19/2023)
Bonds Have Been Awful Investments. It’s a Good Time to Buy (NY Times, 10/16/2023)
2022 was the worst-ever year for U.S. Bonds. How to position your portfolio for 2023. (CNBC, 1/7/2023)
If you are reading this article, I consider you a friend, so please do not ask me about investing in bond funds (including bond ETFs).
NOTE: I also have strong feelings about Series I- Savings Bonds. See the FPH Blog for my article on why I am recommending investors who purchased I-bonds in the past several years consider redeeming them.
