The Federal Reserve’s first interest rate cut in more than four years could be coming as early as this fall — and investors ought to prepare their fixed income holdings for it, according to DoubleLine CEO Jeffrey Gundlach. Fed Chair Jerome Powell answered traders’ prayers on Wednesday when he signaled that a September rate cut could be on the table, provided that inflation data continues to reflect a cooling trend. Central bank policymakers have kept their target interest rate at 5.25% to 5.5% for the past year, creating a yield bonanza for investors in money market funds, certificates of deposit and Treasury bills. Gundlach, speaking on CNBC’s ” Closing Bell ” on Wednesday, said he sees the Fed enacting as much as 150 basis points worth of rate cuts in the next year, or 1.5 percentage points, which would lower the fed funds rate to 3.75% to 4.00%. One basis point equals one one-hundredth of a percent. As interest rates come down, cash, short-dated instruments and floating-rate debt will also see lower yields, translating to less income for investors, he added. “That means the best trade of all for the past couple, three years, which is floating rate assets … you might want to start shifting into fixed-rate securities,” Gundlach said. Indeed, the DoubleLine CEO highlighted BB-rated bank loans in June under a “higher for longer” Fed regime. These instruments were generating yields of 8% at the time. In lieu of those bank loans, investors may want to consider migrating toward BB-rated, fixed-rate high yield bonds — high-yield issues, he said. “The high yield market is tight on spread and the economy is weakening, but the quality of the double-B high yield market is pretty good relative to historical standards,” he said, noting that yields of around 8% are not easy to obtain, but “can be found in a low-risk manner.” Gundlach added that some of his funds have started to make these moves as recently as this week. Be mindful of risk, quality and fees The BB-rated tier of bonds are deemed noninvestment grade by ratings agencies such as Standard & Poor’s and Moody’s. They bring an element of default risk, and may be more closely correlated with stocks than Treasurys. Nevertheless, they do bring the prospect of additional income if you’re willing to take the risk and if these bonds are a part of a diversified fixed income portfolio. Consider that the iShares BB Rated Corporate Bond ETF (HYBB) 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 who are scanning the exchange-traded fund market to play the high yield space ought to dig into the funds’ holdings, understand the quality of the underlying securities, as well as the manager’s strategy if it is an actively managed offering. Stay fee conscious, too, as higher expense ratios dent returns over the long run.
