The year 2024 is upon us, and the financial landscape presents a unique scenario. The Federal Reserve has implemented interest rate cuts for three consecutive meetings, a move typically associated with stimulating economic growth. However, counterintuitively, the yield on the 10-year Treasury bond has risen since the beginning of this easing cycle. This seemingly paradoxical situation arises from the bond market’s interpretation of the economic situation. The market, as reflected in bond yields, is signaling that inflation remains a concern, despite the Fed’s actions. This perspective stems from the robust state of the economy, characterized by plentiful job opportunities and ample liquidity in the market.
Federal Reserve Chairman Jerome Powell appears to be acknowledging the market’s message, adopting a more hawkish stance. This shift is evident in the Fed’s revised guidance, projecting only two rate cuts in the coming year, compared to earlier forecasts of four. This more cautious approach, acknowledging the persistent inflationary pressures, could paradoxically create the conditions for a peak in the 10-year Treasury yield. Supporting this view, the personal consumption expenditures price index (PCE), the Fed’s preferred inflation gauge, recently registered a lower-than-expected reading, prompting a slight decline in the 10-year Treasury rate.
This development aligns with a contrarian perspective that challenges the prevailing assumption that a second Trump administration would inevitably lead to higher interest rates. While many anticipate rising rates under such circumstances, history often demonstrates that widely held expectations can be overturned. Therefore, the “high rates under Trump” narrative might be overblown, creating an opportunity in the bond market. This isn’t to predict a sudden plunge in rates or a change in the “no-landing” economic scenario, but rather to recognize the potential for a shift in market sentiment.
This potential shift creates an opportunity for investors to consider bonds and bond proxies. However, directly investing in Treasuries or investment-grade bonds might not be the most attractive option due to their relatively low yields and the long-term commitment required for Treasuries. Instead, exploring high-yield bonds, specifically through high-yield closed-end funds (CEFs), could offer greater value and higher dividend income. One such example is the PIMCO Dynamic Income Fund (PDI).
PDI stands out due to its management by Daniel J. Ivascyn, a highly respected figure in the bond world, often referred to as “The Beast.” Ivascyn’s extensive network and expertise provide him access to the best new bond issues, contributing to PDI’s impressive performance. Over the past decade, PDI has delivered a total return of 110%, significantly outperforming a benchmark corporate-bond ETF. While PDI currently trades at a premium to its net asset value (NAV), meaning investors pay slightly more than the underlying assets are worth, this premium is lower than its historical average. Considering PIMCO’s reputation and the fund’s consistent performance, this premium could be viewed as a reasonable price to pay.
The strategy of investing in a bond CEF like PDI becomes particularly compelling if, as anticipated, Powell’s more cautious approach leads to a peak in 10-year Treasury rates. As Treasury rates rise, bond prices generally fall. Therefore, purchasing a bond CEF before this potential turning point could position investors to benefit from future price appreciation. While PDI’s premium to NAV might seem like a deterrent, it’s important to consider the context of PIMCO’s consistently high premiums. Compared to its historical averages and the premiums of other PIMCO funds, PDI’s current premium is relatively modest, suggesting it might be undervalued. This combination of factors – a strong track record, experienced management, and a potentially advantageous entry point – makes PDI an attractive consideration for income-seeking investors.
