The intent of every Fed rate hike cycle is to slow the economy. Whether the cycle is driven by a fear of the economy overheating (the last five cycles prior to this one) or is precipitated by already present inflationary pressures (the late-70s and early-80s cycles), the intent is to slow things down. Over the years, and for good reason, bond investors have been conditioned to anticipate an economic recession from Fed rate hike cycles. In other words, more often that not, a Fed rate hike cycle ultimately leads to a recession. In fact, six of the past seven rate hike cycles, going back to the late-1970s, led to an economic recession.
According to the Fed Funds Futures market, we are approximately at the mid-point of this rate hike cycle. The futures market anticipates another 1.5% of rate hikes peaking at the end of March 2023. The table below details how the longer-term bond market, as measured by the yield-to-worst on the Bloomberg Aggregate Bond Index, behaved up to this point and after this point during each of the previous seven rate hike cycles over the past nearly 50 years.
Longer-term yields increased, on average, roughly 1% from the mid-point to the peak of the cycle. As can be seen in the chart below, the peak rate hike cycle yields for the Bloomberg Aggregate Bond Index (white line) always occurred on, or within a month, of the final rate hike (orange line) in each of the previous cycles.
If this cycle continues to stay true to that historic form, we can expect the yield on the Bloomberg Aggregate Bond Index to rise another 1% over the next six months. In short, using seven previous rate hike cycles as a guide, it still isn’t safe to jump back in to traditional, unhedged bonds. History suggests traditional bond indices will remain under pressure until this rate hike cycle is near an end.
If a recession is going to happen, which it did in six of the previous seven rate hike cycles, it usually occurs after the end of the rate hike cycle—on average, about 11-12 months after the last hike. While our sample size for rate hike cycles that didn’t lead to a recession is small (only one), the divergent behavior of longer-term bond yields in a HARD vs SOFT landing scenario is intriguing. The table below details how longer-term yields, as measured by the Bloomberg Aggregate Bond Index yield-to-worst, behaved in the 6 months following the last rate hike.
We find the last column in the above table to be the most pertinent for investors allocating fixed income assets today. Again, using history as a guide, if the end of this Fed rate hike cycle leads to a soft landing (i.e. no recession) then one can expect the yield-to-worst on the Bloomberg Aggregate Bond Index to be approximately 0.60% lower a year from now—about a 6% total return over those 12 months. If this cycle should lead to a hard landing (i.e. recession), one can expect the yield-to-worst on the Bloomberg Aggregate Bond Index to be about 0.46% higher a year from now—roughly a 1.2% total return over those 12 months. While it may not be intuitive that longer-term bond index yields would be lower in a soft landing than in a hard landing, the reason for the divergence is primarily due to widening credit spreads. Corporate bond default risks increase dramatically in a recession.
The pre-merger SPAC universe continues to trade at a 3% annualized discount to current trust redemption value. Those trusts, in turn, are earning the T-Bill rate (another 3% annualized). All in, the conservative expected return of the pre-merger SPAC market over the next 12 months is 6%, regardless of whether the landing is soft or hard. That’s the “best case” outcome for the traditional bond market should the Fed manage to avoid a recession with this rate hike cycle—something it has only accomplished once in the past seven rate hike cycles. Given that every previous rate hike cycle has seen long-term yields increase, on average 1%, over the second half of the rate hike cycle, holding pre-merger SPACs instead of traditional fixed income until this rate hike cycle is done seems to make a lot of sense.
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ABOUT ROBINSON CAPITAL
Founded in December 2012, Robinson Capital Management, LLC, is an independent investment advisor specialized in developing traditional and alternative fixed income solutions. Robinson’s investment approach employs both fundamental and value techniques to best identify positive risk/reward opportunities and to maintain a consistent and disciplined approach. Robinson Capital also specializes in alternative value investing strategies, particularly through special purposes acquisition companies (SPACs) and closed-end mutual funds (taxable and tax-exempt).
Robinson Capital provides customized investment management services for RIAs, family offices, broker-dealers and institutions.
The firm serves as investment sub-adviser to the Robinson Alternative Yield Pre-Merger SPAC ETF (ticker: SPAX). For more information, visit, robinsonetfs.com.
Investors should consider the investment objectives, risks, charges and expenses carefully before investing. For a prospectus or summary prospectus with this and other information about the Fund, click here. Read the prospectus or summary prospectus carefully before investing.
Investing involves risk. Principal loss is possible. ETFs may trade at a premium or discount to their net asset value. Brokerage commissions are charged on each trade which may reduce returns.
The Fund invests in equity securities and warrants of SPACs, which raise assets to seek potential business combination opportunities. Unless and until a business combination is completed, a SPAC generally invests its assets in U.S. government securities, money market securities, and cash. Because SPACs have no operating history or ongoing business other than seeking a business combination, the value of their securities is particularly dependent on the ability of the entity’s management to identify and complete a profitable business combination. There is no guarantee that the SPACs in which the Fund invests will complete a business combination or will be profitable.
Some SPACs may pursue a business combination only within certain industries or regions, which may increase the volatility of their prices. To the extent a SPAC or the fund is invested in cash or cash equivalents, this may impact the ability of the Fund to meet its investment objective. Investments in a SPAC may be considered illiquid and subject to restrictions on resale.
The Fund may purchase warrants to purchase equity securities. Investments in warrants are pure speculation in that they have no voting rights and pay no dividends. They do not represent ownership of the securities, but only the right to buy them. Warrants involve the risk that the Fund could lose the purchase value of the warrant if the warrant is not exercised or sold prior to its expiration. The Fund may also purchase securities of companies that are offered in an IPO. The risk exists that the market value of IPO shares will fluctuate considerably due to factors such as the absence of a prior public market, unseasoned trading, a small number of shares available for trading and limited information about the issuer. Such investments could have a magnified impact on the Fund.
Some sectors of the economy and individual issuers have experienced particularly large losses due to economic trends, adverse market movements and global health crises. This may adversely affect the value and liquidity of the Fund’s investments especially since the fund is non-diversified, meaning it may invest a greater percentage of its assets in the securities of a particular, industry or sector than if it was a diversified fund. As a result, a decline in the value of an investment could cause the Fund’s overall value to decline to a great degree.
The Fund is a recently organized management investment company with limited operating history and track record for prospective investors to base their investment decision.
The Fund is distributed by Foreside Fund Services, LLC.