The bond market has investors ‘in a wait-and-see-mode’ amid rate hikes: Strategist

Alessio de Longis, Invesco Investment Solutions Senior Portfolio Manager, and George Bory, Allspring Global Investments Chief Investment Strategist for Fixed Income, sit down with Yahoo Finance Live to talk about the equity market outlook and sector opportunities amid the Fed's interest rate hikes.

Video Transcript

[BELL RINGING]

- That was the closing bell on Wall Street. Let's throw up the major averages here to see where we ended the day. The Dow closing up just about 239 points. Some buying action here in the final hour of trading. S&P also closing to the upside, just above 4,300. NASDAQ trading to the downside here, holding, though, just above 13,100. In terms of some of the leadership that we're seeing today, Jared just rolled through that for us. Consumer discretionary, consumer staples, financials here among the biggest leaders.

For more on today's markets, let's bring in Alessio de Longis, Invesco Investment Solutions senior portfolio manager. We also have George Bory, Allspring x Global Investments chief investment strategist for fixed income. Alessio, first to you. So we got the better than expected retail data largely speaking squaring that off with that weaker housing data. A bit of a mixed reaction here in the markets today. What's your big takeaway?

- You're on mute, sir. You want to go ahead and-- OK. There we go. If you don't mind starting over. We missed the beginning.

ALESSIO DE LONGIS: My take is that we are still in that phase where the economy is still not feeling the effects of the tightening of the Federal Reserve. So we should be careful in extrapolating at this stage the health of the economy because, really, we are only going to see the impact of monetary policy over a long period of time.

The market is really reacting today about the fall in inflation. It's focusing only on those statistics, how inflation is affecting the future decision making path of the Federal Reserve and how less interest rate hikes may mean higher equity valuations and better bond prices. But we need to be careful in assessing the likelihood of a recession, which I think is still very high.

- George, are the equity markets misreading the Fed? Or are they just putting on their earmuffs?

GEORGE BORY: Yeah. That's a great point. And as my colleague there just mentioned, fixation on inflation hasn't gone away. And it's going to remain the key focal point. The bond market right now is kind of telling you we're in sort of a wait and see mode. The 10-year Treasury is kind of just under 3%, down close around 2.80%.

But if you look across the curve from 2's all the way out to 30, it's 3% plus or minus 25 basis points. I think we're going to be in this consolidation phase for a while. And I would define that as into September. The big question is still the Fed. The Fed has told us clearly they're going to continue to hike rates. But we're normalizing interest rates.

And I think that's what the market is kind of trying to decipher is, can the economy kind of stand on its own? Clearly, tighter monetary policy, higher interest rates does impact economic activity. We've seen it. We've seen the slowdown. But it's not entirely clear that a very hard landing is imminent. It may come. But it may be further out. And it might be softer than expected. And I think that's really what the markets are trying to establish in here.

- I also want to mention we were just showing President Biden signing the Inflation Reduction Act into law just a few moments ago. Alessio, when you take a look at the political policies that we've seen enacted over the last several months, certainly a lot of uncertainty heading in to the midterms. Where are you seeing the most opportunity right now in the market?

ALESSIO DE LONGIS: Well, the opportunity from a sectoral standpoint, I think there is certainly the renewable energy space, the ESG space, which has been leading the way in Europe and is slowly making it into the US as well. But from a sectoral standpoint and the overall opportunities, we have seen an impressive rally in July and a very good continuation in August. And this is happening at a time when the risks in the economy because of the discussion we've just had, the risks in the economy are actually building up.

So our recommendation and what we're doing in our portfolios, we are increasing the exposure to defensive sectors, sectors that screen well on quality characteristics, such as information technology, communication services, health care, consumer staples and have reduced our exposure to cyclical sectors such as financials, industrials, materials, energy.

And I think this comes also as our colleague was just discussing, bonds are now a lot more attractive. So when you compare equities to credit and to government bonds, clearly the need for a rebalance there and beginning to harvest some of the attractive yields that we have, even in the high quality credit space, really make for a sound strategy of rebalancing overall risk.

- And George, Jared Blikre just a moment ago talked about some of the important technical levels that the markets have refound. Can they hold?

GEORGE BORY: Well, I think they can for the time being. I mean, earlier this year back in June when we put out our kind of our mid-year outlook for fixed-income markets, the central message is that it's become a much more bond-friendly world. You asked about political considerations, the bill that's just recently signed. There's certainly a lot in there. But from the bond markets perspective, less spending and sort of tighter fiscal policy is a positive from our perspective.

And then secondarily-- or, really, primarily-- but, really, to sort of reinforce it, central banks here and around the world have moved from a very defensive to a very offensive position in terms of monetary policy and, importantly, financial conditions. And so from that perspective, the world has become a much more bond-friendly place. And we've seen bond yields come down pretty materially from the peaks that we saw back in June.

The technicals right now would tell us we're kind of stuck in a range. So yields are in a range. Spreads continue to notch tighter. And that's likely to continue to grind tighter, but at a much, much slower pace. We saw a massive snapback over the last six weeks. And we're already seeing signs of deceleration as the capital markets pick up, issuance picks up, and the technical balance just becomes a little bit more even keeled.

So as we sort of close out the summer and head into September, our view is the bond market's going to be kind of rangebound in here, kind of looking for those next kind of key data points, all of which leads us to the Fed meeting on September 21. And, obviously, there's a lot of time between now and then. We think that's really going to be what the trajectory is within the bond market.

- All right. George Bory, Alessio de Longis, thanks so much for joining us this afternoon.

GEORGE BORY: Thank you very much.