Allianz Investment: Predicts the Federal Reserve will cut interest rates by 125 basis points from December to next year

According to the Zhitong Finance APP, the results of the U.S. presidential election in November have been announced, with the Republican Trump securing 312 votes and being re-elected as President of the United States. This result has caused fluctuations in interest rates in the bond market. Chen Jiaying, a senior product specialist at Allianz Investment, believes that the Federal Reserve has already begun its interest rate cut cycle in September this year, and short-term rates will gradually decline. Federal Reserve Chairman Jerome Powell also stated that inflation data is gradually easing, coupled with a slowdown in job growth, so whoever is in charge of the White House will not have a significant impact on short-term rates. The Federal Reserve cut rates by another 25 basis points in November, predicting a total cut of 125 basis points from December to next year.

Although the decline in U.S. interest rates will drag down overall bond yields, the current short-term high-yield bond yield remains as high as 7%. Moreover, the current basic forecast is for a soft landing of the U.S. economy, which makes high-yield bonds perform relatively stable, with expectations for next year's short-term high-yield bond yields to be between 6% and 7%. Even if the U.S. falls into an economic recession, Chen Jiaying believes that the default rate of short-duration high-yield bonds will not rise significantly, as the yield curve has been inverted for over two years, yet the U.S. economy remains resilient. Additionally, both large and small enterprises have already prepared for a potential recession in the U.S., with bond issuance amounts being conservative and focusing on cash flow, and leverage ratios not being too high.

Chen Jiaying stated that under the interest rate cut cycle in the U.S., short-duration high-yield bonds will provide investors with attractive yields while having lower interest rate sensitivity. As of October 31, 2024, the yields on U.S. 10-year Treasury bonds and investment-grade corporate bonds are 4.28% and 5.22%, respectively, while the dividend yield of the S&P 500 index is only 1.32%, far below the average yield of 7.5% for U.S. high-yield bonds, making this an attractive investment opportunity for both international and domestic investors.

Chen Jiaying mentioned that, in fact, as of October 2024, the default rate for short-duration high-yield bonds is only 0.55%, significantly lower than the historical long-term default rate of 3.5%. In comparison, the uncertainty of long-term rates is greater, and their volatility is higher due to the many factors affecting long-term rates, such as market expectations for economic growth and inflation, supply and demand for U.S. Treasury bonds, and fiscal policy. However, the effects of these factors take longer to manifest, resulting in greater volatility in long-term rates, while short-term bonds exhibit higher stability.

High-Yield Bonds: High Returns and Diversified Investment Tools

The overall size of U.S. high-yield bonds has expanded from $338 billion in 2000 to $1.38 trillion by December 2023, becoming a favored asset class among investors. Additionally, according to the Bank of America U.S. Dollar High Yield Index from the Intercontinental Exchange, U.S. high-yield bonds account for approximately 62% of the global high-yield bond market and cover multiple industries. The Allianz U.S. Short-Duration High-Yield Bond Fund holds high-yield bonds with maturities of less than 5 years, and as of September 30, 2024, the fund's Class AM (USD) income shares have a return rate of 7.8% this year.

Overall, short-duration high-yield bonds may provide an attractive option for investors seeking high returns. However, investors must carefully assess the default risks and market volatility when considering incorporating them into their portfolios. Through in-depth analysis of the market environment and the fundamentals of issuing companies, investors can better grasp the opportunities and challenges presented by high-yield bonds, thereby formulating more reasonable and effective investment strategies In this rapidly changing financial market, investors who can seize opportunities while effectively managing risks can remain undefeated in the world of high-yield bonds.

Convertible Bonds: A Balanced Approach

In addition to short-duration bonds, investors may also consider another diversified asset - income and growth strategies. The three major U.S. stock indices continue to hit new highs, but the financial market is ever-changing. Besides holding high-yield bonds during a rate-cutting cycle to steadily receive interest income, stock investors can also deploy convertible bonds to hedge against the risk of a stock market decline. When the stock market falls, investors can continue to hold convertible bonds to earn ongoing potential returns; when the stock market rises, investors can convert their held convertible bonds into stocks to capture the potential of the rising market, making it an investment tool that can both advance and retreat.

Since convertible bonds involve the risks of both bonds and stocks, if interest rates rise, the value of convertible bonds may also decline. Additionally, some issuers of convertible bonds have credit ratings below investment grade, which may pose higher risks than investment-grade bonds. Furthermore, investors can also utilize covered call options - holding long positions in individual stocks while selling related call options to earn option premiums. In a flat market, earning option premiums can potentially allow the portfolio's returns to outperform the market, and in a bear market, it can also help offset some of the stock declines, similarly providing an opportunity for the portfolio's returns to outperform the market