Investment Grade Bonds Are a Smart Alternative to Treasuries

The backdrop for being invested in floating rate assets for the past two years has been ideal. The fed funds rate was near zero in the first quarter of 2022. From that point, 11 rate hikes followed as the fight to stem “transitory” inflation got underway.

Fueling the fires of inflation were the substantial stimulus programs in the United States. The federal government obligated approximately $4.5 trillion and expended around $4.2 trillion in COVID-19 relief funds allocated from the CARES Act, Consolidated Appropriations Act and the American Rescue Plan. Add the Inflation Reduction Act ($369 billion), the CHIPS and Science Act ($280 billion) and the Jobs Act ($550 billion), and we are now talking about $5.7 trillion in spent or yet-to-be-spent funds that throttled the federal deficit higher.

The Fed got way behind the curve, which is nothing new, and held rates higher for longer. It has now probably waited too long to start the easing process given the weaker trends in labor and manufacturing, and a noticeable decline in travel demand for summer 2024. As the post-COVID-19 phenomenon of what is termed “revenge travel” wanes, consumers are taking a more cautious approach due to what is a rising sense of an economic slowdown in the making. It is what the Fed wanted; now, it is all about sticking the landing — soft, hard or touch and go.

The bond market has wasted no time making up its mind, but with competing forces at work. Recent data squarely spells out that disinflation is at work, most notably laid out in the Consumer Price Index (CPI), Producer Price Index (PPI) and Personal Consumption Expenditures (PCE) Index data for June. This week, investors will receive CPI and PPI for July, both of which are expected to come in at 0.2%. The headwind for bond yields going forward is not so much deflation, but demand for the ongoing record debt issuance of U.S. Treasuries to fund the soaring budget and budget deficit.

To put this into perspective, over the past year, the national debt increased $2.41 trillion, which translates to $6.65 billion per day. As of July 31, 2024, the total national debt has surpassed $35 trillion. Put another way, over the last decade, national debt balance rose 86%, while gross domestic product (GDP) grew 63%. Conquering goods and services inflation is one thing, but creating a potential scenario of economic fallout from the risks of failed bond auctions is unacceptable.

This should be an alarming milestone to not just taxpayers, but to policymakers, and yet neither candidate running for the White House speaks of the intense fiscal discipline required to avert what the Congressional Budget Office warns of: investors in Treasuries losing confidence in the government’s ability to manage its budget, leading to a sharp rise in interest rates. And while the risk of such an event is currently low, the threat of such a scenario accelerates if the spending binge is not reversed.

For investors that want to have a plan for U.S.-based fixed income, then consider investment grade corporate bond exchange-traded funds (ETFs) and build a laddered portfolio as an alternative to Treasuries. Investing in Fortune 500 balance sheets is arguably a strong consideration given a hyper-indebted government that is showing no signs of fiscal resolve.

There are bond ladder ETFs offered by several investment firms, where strong debt ratings, broad diversification, attractive yields and monthly payments make for an attractive investment proposition. The Invesco BulletShares is one example of laddering out maturities over 10 years and locking in a rate of return at around 5%.

No one can really know if and when the Treasury market will indeed have issues with demand not meeting future supply expectations. For now, a blend of Treasuries and investment grade corporate bonds might make sense to those seeking the safe haven assets managed by America’s strongest companies with fortress balance sheets. With the Fed on track to lower interest rates, it is no surprise that blue-chip debt is under accumulation and will very likely continue to be throughout 2024.