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In a recent webcast hosted by VettaFit, Fixed income in a 5% world, Samarth Sanghavi and Cinthia Murphy explored the new dynamics in the fixed income market.
The Fed hiked rates in September, but Sanghavi opened his remarks by saying this hike was less meaningful than the headlines are suggesting. “I would argue that the turning point in this space was six or seven months ago, earlier this year.” He noted that while the Fed Funds target rate was hiked, other rates set by the market, including the two year and ten year Treasury, were already trading much higher
Prior to the start of the conflict in the Middle East, the two year treasury was trading below the Fed funds rate. According to Sanghavi, this suggests the market was betting on a rate cut. The start of the war saw it shoot above Fed funds, suggesting the market was expecting a rate hike. “By the time you got to the FOMC meeting [in September], the two-year was already trading a full point over the Fed funds rate,” Sanghavi noted.
With yields and interest rates being driven by a host of factors besides the Fed rates, including geopolitical uncertainty, Murphy asked Sanghavi to clarify the most important indicators. “From a rates perspective, I think there are three primary forces at play,” Sanghavi said.
The first force is inflation. Sanghavi observed that inflation has been impacted by the war in the Middle East. Once the U.S. invaded Iran, oil prices jumped, sending energy prices soaring. “Energy is one of these inputs that starts showing up in prices very quickly - we’re talking weeks not quarters.”
The second force is government refinancing. The U.S. government is paying on average 3.4% interest on all its debt. The government will need to rollover $9 trillion worth of debt this year. Sanghavi added, “if you have now have to refinance that debt in a five handle, that’s going to ratchet up interest rate bills pretty quickly.”
The third force is the glut of corporate borrowing. According to Sanghavi, an oversupply of corporate debt pressuring long term Treasury yields. He noted that he is particularly watching the 10-year Treasury. “The ten-year is what’s pricing everything else.”
A poll of the audience attending the webinar saw that 43% would not be changing their fixed income allocations, with 29% saying they were looking to decrease somewhat. 14% said the would increase somewhat, with another 14% saying they would increase significantly.
Both Murphy and Sanghavi expressed some surprise at the results of the poll, and Sanghavi zoomed out a bit to provide a reframe of today’s fixed income realities. “I’m a bit old and I remember the early 2000s when a 5% yield was simply called ‘the bond market.’” He shared a chart showing that the average yield between 1962 and 2007 was actually 7%, while 2008 through 2021 was 2.4%..He asked, “What’s abnormal? Is it the last decade of ultra low rates, or is it the 50+ years of 5% rates that have been the staple in the market?”
In other words, 5% might feel high to folks who have only known the market well in the last decade, but in the longer arc of history, the last ten years are far more abnormal.
Sanghavi shared that for most of his career, the S&P has out-yielded treasury by 2 to 5 points, and often more. He noted he grew up in the era of “TINA” an acronym about equities investing that stands for “there is no alternative.” Things have shifted, pivoting in 2023, shortly after the initial years of the COVID crisis. “Today, the S&P is earning about 3.8% on price alone, whereas a ten-year treasury is earning over 5%,” Sanghavi said, noting that this is the widest gap in favor of bonds outside of the financial crisis. He underscored that this is not a call to liquidate equities, which can grow in ways that coupons can’t, but he did want to stress the importance of this pivot. “For the first time in 15 years, an investor will not need to take on equity risk to generate a decent, consistent income,” he said.
Many investors grow skittish as rate hikes roll in, but Sanghavi looked at the performance of the VettaFi US Corporate Index, noting that when hikes were priced in, the performance was fine. 2022 saw the Fed do more than was priced in, resulting in a weaker performance. “I don’t believe hikes hurt bonds in the long term. Surprises definitely do. This time the market has priced in a point, and the Fed is signalling half of a point.”
Sanghavi cautioned that the long end of the curve is more of a “watch” than “buy” at the moment, before digging in and expressing his views. “I think the next big move in long yields is likelier to be down than up,” he said.
If yields end up rising by more than 1%, long bonds stand to lose 8%. However, if yields fall more than 1%, that could be a 22% bump on returns. That asymmetry makes the long end of the curve worth watching, from Sanghavi’s point of view.
When people think about AI and investing, equities jump to mind. Murphy asked Sanghavi to dig into the less discussed debt side of AI.
“The biggest supply story in IG has been AI,” Sanghavi noted, sharing that hyperscalers like Oracle, Amazon, Google, Meta, Alphabet issued about $16 billion in bonds in 2024. Last year that number jumped to $90 billion. This year, which still has the fourth quarter to go, the number sits at $150 billion. Sanghavi cautioned that nobody knows where this capex is going to pay out. Free cash flow is shrinking and leverage is increasing.
“From an investor’s perspective,” Sanghavi said, “you’re being paid more to take on an uncertain debt on the strongest balance sheets in the market today.”
Murphy asked if this was a bad thing, given the strengths of these companies and Sanghavi agreed that its appealing for investors. He did note that for every dollar of AI debt that any given index can see, there are roughly six it cannot.
Furthermore, estimates indicate that the financing needed for a data center build out approaches $2.9 trillion dollars, over half of which would need to be borrowed. ““Given the stature of these companies, about half of this will be funded by free cash flow alone, but the other half has to be borrowed,” he noted. “That’s about the size of the entire U.S. high yield market today.”
Though these companies are generally some of the largest and strongest in the world, the amount of spending is notable to Sanghavi. He noted that, historically, not every name survives when new technology takes the stage and cautioned that diversification is critical in reducing blow-up risk.
An audience poll revealed a majority of the audience said “no” or was not sure about whether or not they wanted to allocate to AI debt as part of their fixed income portfolio. Despite that, Samarth noted, “If you own any kind of broad investment grade fund today, you already have an allocation to AI debt. The index decided that for you.”
Sanghavi shared a chart indicating how AI hyperscalers have shifted in the VettaFi US Corporate Index. He pointed out that Alphabet has jumped to #12 from #169, indicating its increased borrowing. Only one of the major hyperscalers, Microsoft, saw their ranking decrease. “The index, what it's really reflecting, is who borrows the most, not the quality of the borrower,” he said, adding, “a debt-weighted index, it will continue to allocate the largest allocations to the most prolific borrowers without discerning the quality of that debt.”
Sanghavi said he looks at fixed income as the ballast of his portfolio. “The last thing I want to do is build in a large, unintended concentration into the one part of my portfolio that’s supposed to be defensive. In fixed income, you win by not losing.”
Watch Fixed income in a 5% world here, and learn more.
In a recent webcast hosted by VettaFit, Fixed income in a 5% world, Samarth Sanghavi and Cinthia Murphy explored the new dynamics in the fixed income market.
The Fed hiked rates in September, but Sanghavi opened his remarks by saying this hike was less meaningful than the headlines are suggesting. “I would argue that the turning point in this space was six or seven months ago, earlier this year.” He noted that while the Fed Funds target rate was hiked, other rates set by the market, including the two year and ten year Treasury, were already trading much higher
Prior to the start of the conflict in the Middle East, the two year treasury was trading below the Fed funds rate. According to Sanghavi, this suggests the market was betting on a rate cut. The start of the war saw it shoot above Fed funds, suggesting the market was expecting a rate hike. “By the time you got to the FOMC meeting [in September], the two-year was already trading a full point over the Fed funds rate,” Sanghavi noted.
With yields and interest rates being driven by a host of factors besides the Fed rates, including geopolitical uncertainty, Murphy asked Sanghavi to clarify the most important indicators. “From a rates perspective, I think there are three primary forces at play,” Sanghavi said.
The first force is inflation. Sanghavi observed that inflation has been impacted by the war in the Middle East. Once the U.S. invaded Iran, oil prices jumped, sending energy prices soaring. “Energy is one of these inputs that starts showing up in prices very quickly - we’re talking weeks not quarters.”
The second force is government refinancing. The U.S. government is paying on average 3.4% interest on all its debt. The government will need to rollover $9 trillion worth of debt this year. Sanghavi added, “if you have now have to refinance that debt in a five handle, that’s going to ratchet up interest rate bills pretty quickly.”
The third force is the glut of corporate borrowing. According to Sanghavi, an oversupply of corporate debt pressuring long term Treasury yields. He noted that he is particularly watching the 10-year Treasury. “The ten-year is what’s pricing everything else.”
A poll of the audience attending the webinar saw that 43% would not be changing their fixed income allocations, with 29% saying they were looking to decrease somewhat. 14% said the would increase somewhat, with another 14% saying they would increase significantly.
Both Murphy and Sanghavi expressed some surprise at the results of the poll, and Sanghavi zoomed out a bit to provide a reframe of today’s fixed income realities. “I’m a bit old and I remember the early 2000s when a 5% yield was simply called ‘the bond market.’” He shared a chart showing that the average yield between 1962 and 2007 was actually 7%, while 2008 through 2021 was 2.4%..He asked, “What’s abnormal? Is it the last decade of ultra low rates, or is it the 50+ years of 5% rates that have been the staple in the market?”
In other words, 5% might feel high to folks who have only known the market well in the last decade, but in the longer arc of history, the last ten years are far more abnormal.
Sanghavi shared that for most of his career, the S&P has out-yielded treasury by 2 to 5 points, and often more. He noted he grew up in the era of “TINA” an acronym about equities investing that stands for “there is no alternative.” Things have shifted, pivoting in 2023, shortly after the initial years of the COVID crisis. “Today, the S&P is earning about 3.8% on price alone, whereas a ten-year treasury is earning over 5%,” Sanghavi said, noting that this is the widest gap in favor of bonds outside of the financial crisis. He underscored that this is not a call to liquidate equities, which can grow in ways that coupons can’t, but he did want to stress the importance of this pivot. “For the first time in 15 years, an investor will not need to take on equity risk to generate a decent, consistent income,” he said.
Many investors grow skittish as rate hikes roll in, but Sanghavi looked at the performance of the VettaFi US Corporate Index, noting that when hikes were priced in, the performance was fine. 2022 saw the Fed do more than was priced in, resulting in a weaker performance. “I don’t believe hikes hurt bonds in the long term. Surprises definitely do. This time the market has priced in a point, and the Fed is signalling half of a point.”
Sanghavi cautioned that the long end of the curve is more of a “watch” than “buy” at the moment, before digging in and expressing his views. “I think the next big move in long yields is likelier to be down than up,” he said.
If yields end up rising by more than 1%, long bonds stand to lose 8%. However, if yields fall more than 1%, that could be a 22% bump on returns. That asymmetry makes the long end of the curve worth watching, from Sanghavi’s point of view.
When people think about AI and investing, equities jump to mind. Murphy asked Sanghavi to dig into the less discussed debt side of AI.
“The biggest supply story in IG has been AI,” Sanghavi noted, sharing that hyperscalers like Oracle, Amazon, Google, Meta, Alphabet issued about $16 billion in bonds in 2024. Last year that number jumped to $90 billion. This year, which still has the fourth quarter to go, the number sits at $150 billion. Sanghavi cautioned that nobody knows where this capex is going to pay out. Free cash flow is shrinking and leverage is increasing.
“From an investor’s perspective,” Sanghavi said, “you’re being paid more to take on an uncertain debt on the strongest balance sheets in the market today.”
Murphy asked if this was a bad thing, given the strengths of these companies and Sanghavi agreed that its appealing for investors. He did note that for every dollar of AI debt that any given index can see, there are roughly six it cannot.
Furthermore, estimates indicate that the financing needed for a data center build out approaches $2.9 trillion dollars, over half of which would need to be borrowed. ““Given the stature of these companies, about half of this will be funded by free cash flow alone, but the other half has to be borrowed,” he noted. “That’s about the size of the entire U.S. high yield market today.”
Though these companies are generally some of the largest and strongest in the world, the amount of spending is notable to Sanghavi. He noted that, historically, not every name survives when new technology takes the stage and cautioned that diversification is critical in reducing blow-up risk.
An audience poll revealed a majority of the audience said “no” or was not sure about whether or not they wanted to allocate to AI debt as part of their fixed income portfolio. Despite that, Samarth noted, “If you own any kind of broad investment grade fund today, you already have an allocation to AI debt. The index decided that for you.”
Sanghavi shared a chart indicating how AI hyperscalers have shifted in the VettaFi US Corporate Index. He pointed out that Alphabet has jumped to #12 from #169, indicating its increased borrowing. Only one of the major hyperscalers, Microsoft, saw their ranking decrease. “The index, what it's really reflecting, is who borrows the most, not the quality of the borrower,” he said, adding, “a debt-weighted index, it will continue to allocate the largest allocations to the most prolific borrowers without discerning the quality of that debt.”
Sanghavi said he looks at fixed income as the ballast of his portfolio. “The last thing I want to do is build in a large, unintended concentration into the one part of my portfolio that’s supposed to be defensive. In fixed income, you win by not losing.”
Watch Fixed income in a 5% world here, and learn more.
