The Federal Reserve’s first interest rate cut in more than four years could come as soon as this fall, and investors should prepare their bond holdings for it, according to Jeffrey Gundlach, CEO of DoubleLine. Fed Chairman Jerome Powell answered traders’ prayers on Wednesday, suggesting that a September rate cut could be on the table as long as inflation data continues to show a cooling trend. Central bank policymakers have kept their target interest rate steady at 5.25% to 5.5% over the past year, providing a yield boon to investors in money market funds, certificates of deposit and Treasury bills. Gundlach said on CNBC’s “Closing Bell” on Wednesday that he sees the Fed cutting interest rates by as much as 150 basis points (1.5 percentage points) over the next year, lowering the federal funds rate to 3.75% to 4.00%. A basis point is equal to one-hundredth of a percent.When interest rates fall, so do yields on cash, short-term securities and floating-rate notes, reducing investors’ income, he added. “So the best deals over the last couple of years have been floating-rate assets. You might want to start moving to fixed-rate securities,” Gundlach said. In fact, DoubleLine’s CEO in June took a bite out of BB-rated bank loans under the “longer-term, higher-rate” Fed regime. These instruments were yielding 8% at the time. Instead of these bank loans, he said, investors might want to consider moving to BB-rated fixed-rate, high-yield bonds, or high-yield bonds. “The spreads in the high-yield market are tight, and the economy is weakening, but the quality of the double-B high-yield market is pretty good relative to historical levels,” he said, noting that while yields around 8% aren’t easy to come by, “you can find them with low risk.” Gundlach added that some of his funds have started making these moves as recently as this week. Beware of risk, quality and fees BB-rated bonds are considered non-investment grade by rating agencies such as Standard & Poor’s and Moody’s. They have an element of default risk and may be more correlated with stocks than government bonds. That said, if you’re willing to take on the risk and these bonds are part of a diversified bond portfolio, there’s the potential for additional income. Consider the iShares BB-Rated Corporate Bond ETF (HYBB), which has a 30-day SEC yield of 6.22%. The fund has an expense ratio of 0.25%. State Street offers the SPDR Portfolio High Yield Bond ETF (SPHY). The fund has a 30-day SEC yield of 7.68% and an expense ratio of 0.05%. Investors exploring the exchange-traded fund market to invest in the high-yield space should take a closer look at the fund’s holdings, understand the quality of the underlying securities, and, in the case of actively managed, understand the manager’s strategy. They should also be mindful of fees, as high expense ratios reduce returns in the long run.
Gundlach says investors should look for solid yields in this asset ahead of Fed rate cuts
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