Few bond fund managers erupt into contagious laughter when talking about the market’s reaction to the latest inflation data released on Thursday. A 0.3 percent increase in the consumer price index between September and October — two-tenths less than what economists expected — kicked off a huge rally in bonds. The yield on the two-year Treasury, a barometer of Fed policy, declined to 4.32 percent from 4.63 percent. The rate hikes have roiled markets this year, inflicting historic damage on bonds.
In between laughs, Bill Eigen, portfolio manager of the JPMorgan Strategic Income Opportunities Fund, had a lot to say about how wrong investors are in their interpretation of the inflation data. “That means the Fed’s done. It’s over. They’re going to stop now. That’s what the market is pricing!” he boomed.
Eigen is always up for a raucous conversation about what’s happening behind the curtain in fixed income, particularly when he’s doing the opposite of everybody else, which is often — and maybe all the time. Unlike most traditional bond managers, Eigen has that freedom. Strategic Income Opportunities is a go-anywhere absolute return fund that can go long and short and isn’t judged by how well it does compared to its peers. His thought process is different because the fund’s mandate is to deliver positive returns — no matter what’s happening in fixed-income markets.
Signs of trouble are clear, he said, even if no one is paying attention. High yield is trading at 450 basis points over Treasuries, which implies that there are virtually no defaults and the economy is healthy, if not robust. But Eigen isn’t buying it. Despite the rally, inflation is not coming down in a material way anytime soon. At the same time, defaults have begun and junk bond issuers aren’t getting deals done.
“People are celebrating a near 8 percent CPI print,” he said. “This is the fourth Fed pivot rally this year.”
But then Fed Chair Jerome Powell comes back even more hawkish because, as Eigen said, “the Fed’s work isn’t even close to being done” and investors give it all back. For years everybody said ‘don’t fight the Fed,’ but now when the Fed is the most aggressive it’s been in 40 years, laying its path out clearly, people aren't listening. “All I do is just listen to the Fed, and I believe them.”
Eigen’s thinking, along with the fund’s positioning, tells a particular story about the fixed income markets and how the world got here.
Last year, Eigen watched warily as the Fed’s easy money policies combined with government stimulus. “This is the most defensively I’ve ever been positioned in my whole career.” Eigen, who is also head of the absolute return and opportunistic fixed-income team at J.P. Morgan Asset Management, is holding 60 to 70 percent of the fund in cash. Last year he sold off all high-yield and took short positions in some parts of the credit default swaps market, including investment grade and high yield.
He got even more defensive in January. Inflation was picking up, hitting 5 to 6 percent by February, but the Fed was sitting still. In fact, it was running quantitative easing into March. “I thought that was the definition of insanity. We’re sowing the seeds of something horrible here and the Fed is acting as if everything is transitory.”
Eigen is now waiting patiently to put the fund’s cash to work. “I need to see high vol, need to see signs of a real liquidity release. I’m seeing it in some segments, like certain MBS, CMBS that are absolutely melting down. You see some securities go from par to 60, but no one talks about that. Throughout my entire career that is how it always starts.”
He’s used to running in the other direction. In 2016, the fund loaded up on high yield at a time when the market hated junk bonds or, as he colorfully put it, “they were in the toilet.” Now there’s a chorus of criticism for his cash position. But the fund is down a little more than 20 basis points, even as most core and core plus bond funds are down almost 16 percent through the end of October.
Bond managers have to share the blame. Since the 1980s, fixed income has been in a bull market as rates consistently fell. Few people have managed money during a bear market in bonds. And this time around, with rates near zero, investors didn’t have any income to cushion the declines in value.
Eigen says the double-digit losses that investors have suffered highlights other perennial mistakes. With rates so low for so long, investors fell for strategies that promised more yield without more risk. “My military dad always said, ‘at some point you gotta pay the price for the things you’ve done.’”