The second half of 2022 'still looks positive for the bond market': Strategist

Kathy Jones, Charles Schwab Chief Fixed Income Strategist, sits down with Yahoo Finance to discuss the bond market's fortitude against current economic slowdowns and recession indicators like metal commodity pricing.

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- Well, let's get a temperature check on the markets with our guest, Kathy Jones, Charles Schwab chief fixed income strategist. So as we heard there, the S&P 500 on track for its worst day in 52 years. But it's not how you start. It's how you finish. How would you characterize where we are now and what you're expecting for the year ahead?

KATHY JONES: Well, I think we've had just a slew of economic reports that suggest that the economy is slowing down and that some of the inflation pressures are starting to ebb. And whether it's from the manufacturing sector or the service sector, we're starting to see things kind of roll over. And a lot of this simply has to do with the tightening that we're getting from the Federal Reserve.

And once you start to move in that direction, the economy starts to react. And it's reacting pretty quickly because the Fed is indicating it's going to move pretty quickly. So we're kind of saying the air come out of the speculative or the riskier parts of markets. And so I do see treasuries do a little bit better, which is typical of when you see a growth slowdown.

- Kathy, how long do you expect this slowdown to last? I know you noted in your notes that you sent over the pace of Fed tightening, maybe that will lessen just in terms of what we could see if we look out towards the end of the year. What does that mean for investors?

KATHY JONES: Well, we could get a bit of a reprieve from the Fed, not so much because the markets are selling off, but more because the economy appears to be slowing down. So they've tried to frontload their tightening to get ahead of the inflation pressures. And by doing that, they're signaling tighter conditions and slower growth.

And they may actually not have to raise rates as rapidly as they say later this year. We still expect a 75 basis point hike probably in July and a little bit more tightening. But it may not be so bad. And that might give us a little bit of a reprieve in the markets as we get towards the end of the year.

- Perhaps a 25 in September. Good news in short supply, isn't it, Kathy? The second half is looking positive for whom and why?

KATHY JONES: Well, I think it still looks positive, actually, for the bond market because it's priced in a tremendous amount of tightening. And if we don't get it and we do get that slower growth, then yields can start to come down a bit. And then that should help the risk assets as well. But again, that's going to be probably a slower progression because we still have to get through the Fed tightening before we turn around and see where the recovery in risk assets will be.

So when we look at, say, the bond market, we're looking at corporate bonds with investment grade ratings or municipal bonds with investment grade ratings as the higher quality parts of the markets that we find attractive on a relative basis.

- And I want to ask you about falling copper prices, which do tend to indicate a looming recession. What are the expectations of how soon and how deep the recession could be based on what you're seeing there?

KATHY JONES: Oh, boy. It's a little tough to say at this stage of the game because we have a lot of recession indicators that are moving in that direction. But we still have a relatively healthy job market. And that tends to work against the predictions of an imminent recession. We have seen corporate profits come down pretty substantially from very high levels. And that's partly because interest costs have gone up, labor costs have gone up, and now we're seeing a slowdown in demand.

And so for a lot of companies, that's going to continue to put a bit of a squeeze as we go in the second half of the year. But again, I think that if those interest costs start to level off and not continue to go up, if we get slower growth, the wage pressures will level off, and then we'll start to see corporate profits come back.

- Kathy, one of the worrisome signs that we've seen in terms of data points recently has been on the consumer side of things, when you take a look at consumer confidence falling to the lowest level that we've seen in nine years. Consumer sentiment also dropping as well. What does this mean for investors when we try to gauge what the next three to six months are going to look like?

KATHY JONES: Yeah. Two of the data points that are really discouraging is the weakness in consumer sentiment because it's very unusual when unemployment is this low to see consumer confidence so low. And that usually translates into slower spending down the road because people are more concerned about the future.

And the other data point is in the small businesses, where expectations are quite negative there. And the smaller businesses account for a lot of hiring, the vast majority of hiring. So the fear is that they'll slow down in hiring because they're so discouraged about the prospects for the future. So those are the two data points that make me most concerned. And I think we need to see some improvement there before we start to see sentiment turn around.

- On that one, a "New York Times" poll today shows 14% of Americans say they're better off than a year ago. That's an all-time low. We continue to hear numbers like that. So all this being said, Kathy, what's the strategy you recommend for the second half?

KATHY JONES: So we're still pretty cautious. We're trying to play it as defensively as we possibly can. We're looking more positively towards fixed income in the second half of the year after a brutal start to the year, but only in those high credit quality areas of the market. And I'd say that's similar to our view on the stock market, is still play defense and stay out of the more speculative parts of the market until we get some good news on the horizon about rates.

- And in terms of what to avoid in speculative markets, what are you keeping away from?

KATHY JONES: Well, high yield. The companies with no profits. The small tech companies with no profits. Areas like that that simply have bubbled up because there was so much free money around. And now we're looking at those as areas to stay away from.

- Kathy Jones from Charles Schwab. Not all good news. We very much appreciate it nonetheless.