This is the biggest opportunity in fixed income at the moment – 06/09/2023 – From Grain to Grain

As I have been writing recently, it is already known that the Selic rate should start to fall in the second half of this year. The strong drop in the Selic is already expected, as interest rates on government bonds have already dropped and reflect this movement. Therefore, there is not much to be gained through government bonds with variable rates. However, there is another type of fixed-income bond that has the same earning potential that Treasuries have shown over the last three months.

So that you understand, I will explain what happened to public bonds. Consider the IPCA 2035 Treasury bond. The maximum real rate that this bond reached in the last 5 years was close to 6.5% per year. This took place in early March of this year.

Surprisingly, over the past three months, the rate on this bond has dropped from 1.25% to 5.35%. This drop led to a 17% price gain for this security in the period.

The gain in price of a security by variation in the rate can be estimated in a simplistic way. Simply multiply the term to maturity of the security, in the case of the example, 12 years (2035-2023), by the rate variation. So 12*1.25% = 15%. This account is not accurate, but it gives an idea of ​​the gain explanation.

Note that for the gain that occurred in the last three months to be repeated, the rate on this bond would have to drop to 4.10% per annum.

Let’s face it, it seems unlikely that this will happen in less than a few years.

Therefore, it would not be by investing in government bonds that you could capture a similar price movement in the short term.

However, some corporate bonds may provide gains similar to what happened with public bonds in the last quarter.

Private bonds trade at a rate premium or spread above the equivalent government bond rate. That spreador the bond’s rate of return above a public bond is justified by the credit risk.

The JGP manager calculates this spread average of private securities and periodically discloses it.

O spread of private securities increased significantly in the first quarter of this year as a result of greater investor fear after the events of some companies such as Americanas and Light.

However, the increase was too much and, according to the last report produced by JGP, the spread is already starting to give way.

The evolution graph of this spread is shown in the figure above. In the chart on the left, you can see that the spread in 2022 was around 1.7%. This means that private securities had, on average, a return 1.7% higher than the public equivalent.

In the graph on the right, it can be seen that this premium rose to 3% in March 2023. spread can be seen in this same graph. It has already dropped to 2.76%.

If the premium that investors charge for investing in corporate bonds returns to last year’s average, the interest rate on these bonds would fall in a similar way to the drop observed in government bonds in the last 3 months.

This one spread should return to the average of the previous year in the coming months. This rate movement could promote a large price gain in corporate bonds. Thus, as occurred in public bonds.

Remember, the longer the bond’s maturity, the greater the potential gain from interest rate changes.

Michael Viriato is an investment advisor and founding partner of Investor House.

Talk directly to me via email.

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