Investors Riding the Waves in Unsteady Bond Market

MIKE TOWNSEND: On January 20, Donald Trump took the oath of office as the 47th president, and Washington is undergoing a rapid change, almost too much change to keep track of. The president signed more than 50 executive actions in his first week in office, targeting everything from immigration policy to diversity, equity, and inclusion programs at federal agencies to starting the process of withdrawal from the World Health Organization and the Paris Climate Accord. For the markets though, probably the biggest news from week one of Trump's presidency was the lack of any of the long-promised executive orders imposing broad tariffs. Instead, there was an order that directed key federal agencies to undertake a sweeping study of trade policy and report to the White House by April 1.

In comments throughout his first week, President Trump did threaten to impose tariffs on Canada, Mexico, China, and the European Union as soon as the beginning of February. And he engaged in a weekend war of words and tariff threats with South American ally Colombia. But the across the board tariffs that Trump talked about on the campaign trail have not materialized, at least not yet. The stock market took notice, with the S&P 500^® up 1.74 % for the first week of Trump's presidency, the best first week for any president since 1985, the second term of Ronald Reagan's presidency. But the bond market was mixed, as bond investors seem to be having a tougher time sorting out some of the contradictory messages from the new administration. We can put the Federal Reserve in that camp as well. In its first monetary policy meeting of 2025, the Fed Open Markets Committee held the fed funds rate steady—in no small part because it too is waiting to see how the new administration's policies will affect the economy. It's looking like choppy waters ahead for bond investors. 

Welcome to WashingtonWise, a podcast for investors from Charles Schwab. I'm your host, Mike Townsend, and on this show, our goal is to cut through the noise and confusion of the nation's capital and help investors figure out what's really worth paying attention to. 

On today's episode, we're going to take a closer look at the fixed income markets. Bond investors have been on something of a roller coaster over the last couple of years, and yields have been surging in recent months. There's uncertainty about how the bond market will react to some of the new administration's policy initiatives on trade, immigration, taxes, and more. 

And the Fed is also sending signals that rates may not come down as quickly as the market thought would be the case a few months ago. All of it is contributing to increased anxiety for fixed income investors, who for many years have thought of their bond holdings as the steady-as-she-goes part of a portfolio. Joining me in just a few minutes to sort through it all will be Collin Martin, director and fixed income strategist here at Charles Schwab. 

But first, here are three things investors need to know about what's going on in Washington. First up, we've talked on this podcast about how the debt ceiling is going to be one of the big issues to watch in the first part of 2025. Well, the countdown clock has officially begun. Last week, the Treasury Department began taking so-called extraordinary measures, a series of accounting maneuvers to ensure the United States does not default on its debts. The steps themselves aren't anything new. They've been part of the debt ceiling playbook for many years, but they are temporary steps, and they mean that Congress has to raise or suspend the debt ceiling in the coming months. We don't have an exact date for the default deadline, but it's likely to be late spring or early summer.

President Trump and Republican leaders on Capitol Hill would love to get this issue resolved quickly, but they face a divided Republican caucus in Congress. Seventy-one House Republicans voted against the last debt ceiling deal in 2023, and a handful have never voted for a debt ceiling increase. One path being discussed is attaching a debt ceiling increase to legislation providing emergency aid to victims of the California wildfires. Democrats are opposed to tying these issues together, but it makes sense politically for Republicans, as it would likely force some Democrats to vote for the debt limit increase in order to secure the emergency aid. 

A second option could be to attach a debt ceiling provision to the upcoming government funding bill. The current agreement to fund government operations expires on March 14th, so Congress must extend the funding or pass the 12 appropriations bills that fund every federal agency and program by that date to avert a government shutdown. 

And a third option is to include a debt ceiling increase in the large tax and budget policy bill that Republicans are developing for consideration later this year. It's not clear, however, whether that bill will be ready before the debt ceiling deadline. At the moment, there is no consensus on how to proceed, but with the clock ticking, and the memories of the 2011 downgrade of the U.S. credit rating in the aftermath of the prolonged debt ceiling fight that year, Congress must move quickly to avoid putting yet more stress on the bond markets. 

Second, another issue that we flagged as one to watch is cryptocurrency, with a growing sense that policies clarifying the regulatory framework for digital assets could come together in 2025. The first week of the new administration saw a flurry of moves to advance that effort. President Trump announced the formation of a presidential working group on digital-asset markets, which will include key regulatory agencies and be chaired by his new AI and crypto czar, David Sacks, the former chief operating officer at PayPal. Part of the group's mandate is developing a regulatory framework for digital assets, as well as evaluating the possible creation of a national digital-asset stockpile, often referred to as a Bitcoin strategic reserve. 

Over at the SEC, Commissioner Mark Uyeda was named acting chairman while the agency waits for Senate confirmation of Paul Atkins, the president's nominee for permanent chair. In one of his first official acts, Uyeda announced the formation of a crypto task force at the regulatory agency. Commissioner Hester Peirce will chair the effort, which will include staff from across the agency working together to develop a comprehensive and clear regulatory framework for crypto assets. Finally, on Capitol Hill, the Senate Banking Committee last week approved the creation of the first ever Senate Subcommittee on Digital Assets. Senator Cynthia Lummis, a Republican from Wyoming who is a longtime proponent of crypto, will chair the subcommittee, with new Senator Ruben Gallego of Arizona serving as the panel's top Democrat.

There's already a Subcommittee on Digital Assets at the House Financial Services Committee, and the two panels are expected to coordinate their efforts. 

Taken together, these moves make it pretty clear that cryptocurrency legislation will be a high priority in 2025. But it also seems like a lot of cooks in the kitchen. So I'll be following this closely in the coming months to see if everyone can stay aligned and turn a multitude of ideas into cohesive legislation that can make it all the way to the president's desk. 

And finally, I've also got my eye on the changing scope and status of the DOGE, the Department of Government Efficiency. That's the effort to reduce federal spending that was originally going to be co-chaired by Elon Musk and Vivek Ramaswamy. But before it even got off the ground, there were reportedly clashes between the two co-chairs over the direction of the new entity.

And now, Ramaswamy is out. He announced that he would instead run for governor of Ohio in 2026 and left the DOGE effort to start his campaign. But the leadership of the DOGE is far from the only major change. When originally described, the DOGE was going to be a non-governmental entity that would focus on making recommendations to the president and Congress about ways to cut spending from the federal government. 

Musk said in November that his goal was $2 trillion in spending cuts. More recently, he lowered that goal, saying a trillion dollars in cuts would be a success. However, when President Trump signed an executive order during his first week in office creating the DOGE, it looked very different. An existing governmental entity, the U.S. Digital Service, which was launched by former President Barack Obama in 2014 to improve the digital experience of interacting with the federal government, will now house the U.S. DOGE service. The focus now will be on modernizing federal technology and software to maximize governmental efficiency and productivity. There was nothing in the order about cutting federal spending, reducing regulations, or overhauling federal agencies.

The new direction of the DOGE is frankly a bit bewildering. Each federal agency will have a four-person DOGE team, including a software engineer, a human resources expert, and an attorney. They'll be charged with seeking out departmental inefficiencies, which many observers suggest would include identifying spending and regulation reductions. But it's not clear how these teams would go about recommending those changes or how they would be implemented.

The executive order gives the DOGE until July 4, 2026, to do whatever it is that it's going to do before being shut down. The initial reaction in Washington has been that this represents a major reduction in scope and ambition for the project, though that remains to be seen. Stay tuned.

On my deeper dive today, I want to take a look at the state of the bond market and how all of the uncertainty surrounding the policy agenda is impacting fixed income investors. To do that, I'm pleased to welcome back to the podcast Collin Martin, director and fixed income strategist here at Charles Schwab. Collin has been with Schwab for more than 12 years, and he holds the Chartered Financial Analyst designation. I've always been a bit intimidated by the bond market, but Collin has a great ability to make it understandable. Collin, welcome back to WashingtonWise. Thanks so much for joining me today.

COLLIN MARTIN: Thank you so much for having me. I hope by the end of this, you will be less intimidated by the bond market.

MIKE: Well, let's hope so. Collin, the bond market took investors on quite a wild ride in 2024. And that story seems to be continuing. Yields have risen sharply over the last few months and into early 2025. What has traditionally been the stable side of our portfolios, the part that we did not have to really concern ourselves with, it feels like it's become much more of a concern. You follow the bond market so closely, it's a wonder that you haven't gotten whiplash from all those gyrations.

COLLIN: Yeah, it has been a wild ride, Mike. The past few months, even few years, we've seen a lot of movements in the bond market with the aggressive pace of rate hikes that began a few years ago. And then the question of when will those cuts come? What will the magnitude be? What really, I think, surprised a lot of market participants over the past few months was the idea that the Federal Reserve began cutting rates back in September of 2024. And then after that happened, long-term Treasury yields actually rose. So I think that probably caught a lot of investors off guard because long-term Treasury yields had begun to fall in anticipation of those rate cuts. But then once those rate cuts arrived, looked like the economy was actually proving to be a bit resilient. Inflation, while it had moved down, it was looking like maybe it was going to stay a little bit sticky. And while expectations were still there for the Fed to cut rates a couple more times, expectations shifted about how much they would ultimately cut over time. 

And the markets are forward looking, like I alluded to. And if you look at something like a five or 10 year Treasury, that's based on expectations of the fed funds rate over the next few years. So when the idea was the fed funds rate might fall to, say, 3% or so—those expectations have been revised up to closer to 4%—long-term yields rose kind of in sympathy there. So I think that caught a lot of investors off guard that the Fed cut rates and then cut a couple more times through the end of last year. And yet we saw long-term Treasury yields continue to rise.

MIKE: Yeah, analysts like you can keep a cool head, but all the volatility keeps the rest of us wondering where our bond portfolio stands. It's always confusing, at least to me, to talk about yields because whichever way they're going, it seems it's good for some and not so good for others. Hence the concern bond investors feel. It leaves investors wondering whether they are doing better if yields are up or if they're doing worse.

COLLIN: Yeah, Mike, that's a good way to phrase it. Are they doing better or worse? And it really does depend. It means some investors could be doing better if they're looking to invest right now. Yields are higher today than they were just a few months ago. So I referenced the 10-year Treasury yield. It fell to the 3.5% to 3.75% range back in September of 2024. In early 2025, it was back above 4.5%. So if you're looking to invest today, it's a good thing. You can earn higher yields. Now, it can be a bad thing if you're a bond holder because one of the most standard relationships with bonds and bond investing is that their prices and yields move in opposite directions. So I think that's where a lot of the angst comes from. So when yields rose like they have over the past few months, the value of a lot of bond investments likely fell. And that can be discouraging when you buy what you think are probably high-quality investments like U.S. Treasuries, you expect to get your money back as promised, only to see the value fall when you log into your account. And I think that can be a tough pill to swallow. But I said that depends in terms of if you're doing better or worse because those price declines that we're seeing, they're temporary in nature if you hold those bonds to maturity. That's a key difference between stocks and bonds. Stocks are essentially perpetual investments, where if you look at a bond, they have maturity dates. They have par values. So if you buy a bond, and you plan to hold it for five years, and you see the price fluctuate because yields are moving in the secondary market, those price fluctuations might not matter because you can be fairly certain, as long as you're investing in high-quality investments, and barring default, that you can get that money back. So I think that's important to kind of differentiate and almost look through those price declines where they'll only be temporary if you plan to hold to maturity.

There is another way of looking at it where it could be an opportunity cost, where if you invested in a 10-year Treasury, say four months ago or so, near that 3.5% range, and today you can get closer to 4.5%, there's an opportunity cost there that you locked in a lower rate. But again, if you hold to maturity, you'd still get that money back at maturity, and you'd get that income payment as promised by the U.S. government.

I think this does confuse a lot of investors. And I find that an example that compares bonds to CDs can help a little bit. Because I find that lot of investors, they understand what a certificate of deposit, or a CD, is, but they say they're confused by the bond market. They're similar investments. If you invest in a CD, you're giving money to a bank. They're going to hold that money for a predefined period of time, whether it's six months, 12 months, or it could be as long as five years. And then you'll get your money back and a stated interest rate. And there's FDIC limits, of course, that come into play. Now with a bond, it's very similar. There are stated terms, where you have an interest rate, you have a maturity date, the maturity value that you'll get back at maturity barring default. But you see those price declines with a bond, like a Treasury, that you don't necessarily see with CDs if you opened up an account with a bank. But they're very similar investments. So if you're OK locking up your money with a bank for a set period of time, whether it's 12 months or five years, it's similar with bond investments that you might see price fluctuations over time, but barring default, you'll get your money back from the issuer at the end of the stated term.

MIKE: Yeah, I appreciate your discussion of CDs. I agree with you. I think the ordinary person understands a CD and somehow finds bonds a little more confusing. So I appreciate the connection you make there. I was thinking, Collin, as investors like us may be having a hard time tracking all of this, I think the Fed must really be working overtime to try and keep it all straight, to keep the economy and employment on a positive path.

The Fed announced that it was holding rates steady this week, which I don't think surprised anyone, but there remains a fairly wide dispersion of opinions about where rates are going just within the Fed itself. After the December meeting, according to the dot plot, at least one Fed voter thinks there won't be any rate change at all by the end of 2025, while there are others who thought that the rate could be down by a full percentage point or more. On the other hand, many analysts seem skeptical that the fed funds rate will come down much at all. Somehow this just doesn't feel normal with analysts seeing things very differently from what the Fed is telegraphing.

COLLIN: Well, it's been an interesting handful of years, Mike. As we came out of the pandemic, a lot of the historical relationships that used to hold, they didn't all work this time around. So a lot of models that economists have, or Fed economists have, market strategists have, they didn't necessarily work. Where there's this standard idea that people think if you raise rates, that should slow consumption patterns, it should slow spending, and that can help bring inflation down. But there are so many moving parts coming out of the pandemic with all the fiscal stimulus, the monetary stimulus, those relationships didn't hold. So it's a really challenging job for the Federal Open Market Committee. And they're the policymaking board of the Fed that sets monetary policy and sets the fed funds rate. You made a good point before about the dispersion of opinions. And I find that probably confuses a lot of investors because one day you might turn on the TV and hear a Fed official talking about the idea that they don't want to cut rates at all. And then you might turn on a different channel the next day, and there might be another official talking about cutting rates four more times. There's this wide dispersion, but that's because the Federal Open Market Committee is just that—it's a committee. It's a committee of individuals, and they all have their different views. And they all might focus on different parts of the economy or focus on different data points that's going to help them reach their dual mandate. So the Federal Reserve has a dual mandate of maximum employment, which is the labor market, and price stability, which is another way of talking about inflation. And each committee member or Fed participant might have a different idea and different outlook of what's going to happen over the next few months or quarters. And that plays into their outlook. So you mentioned those dots. At every other meeting, or four meetings a year, the Federal Open Market Committee, the participants, release their projections on the economy and where they see the fed funds rate being over the next handful of years. And what we as strategists and market participants do is we look at those projections, and we call them dots because the actual visual, they're little dots on a table. We look at the dispersion of those Fed views, but we look at that median to get an idea of is there a consensus where the rate might be at the end of this year? As it stands today, despite some dispersion, as you mentioned—one person is not projecting any cuts, someone's projecting four cuts—the median projection calls for two cuts this year. And market expectations are generally in line with that. When we talk about market expectations, we're talking about the fed funds futures market. And that's where large institutional investors across the globe are investing based on their expected path of the fed funds rate. And right now they're aligned, and they haven't always been aligned. That can change. Market expectations tend to change a lot more quickly than the Fed because we only get those Fed projections four times a year where market projections can take every incoming economic release and reprice accordingly. 

As it stands now, we at Schwab are pretty close to both of those projections and expectations. We expect two rate cuts this year, but we don't think the next cut will come until the second half of this year because inflation is proving to be a little bit sticky. But I'd highlight that things can change quickly. If we get some really good inflation readings over the next few months—and when I say good, I mean lower than expected—maybe we'll see more rate cuts.

On the flip side, if we see inflation come in a little bit hot over the next few months, that will probably push out expectations of the number of cuts, or maybe rate cuts will be priced out altogether. So it's a moving target. But for now, we still do think two rate cuts, but probably not until the second half of this year.

MIKE: Well, as the Fed sorts through everything that's going on, there's another voice coming, and that is the new voice in the White House. President Trump said often on the campaign trail that he wanted a larger voice in monetary policy decisions. In his first term, he did a lot of complaining about the Fed. There was some talk about whether he would fire Fed Chair Jerome Powell. It's not even clear that he could do so, but he's appeared to back away from that. Last week, however, when speaking to the World Economic Forum in Davos, Switzerland, Trump said he would demand that interest rates are lowered immediately. And he later told reporters that he understands interest rates much better than Powell. Throughout its history, the Fed has successfully resisted presidential pressures. But with Trump doubling down on his desire to have more control over the Fed, one of the most common questions I'm getting from clients these days is around the Fed's ability to retain that independence.

COLLIN: Oh, Mike, that's a tough job to have these days. Can you imagine you're the head of the Federal Reserve, and the president is constantly telling you how to do your job? That's going to be a challenge. I'm not envious of Fed Chair Powell right now. But you mentioned Fed independence and the Fed's ability to remain independent. We don't expect the Fed to lose its independence. So we don't expect Powell to be fired. We expect him to serve out the remainder of his term, which comes up in 2026. We don't expect Congress to change the Fed's mandate of price stability and maximum employment. What I do expect is President Trump to continue talking about the idea of lower interest rates and talking about what he wants. But we don't think that Fed officials will necessarily listen to that. I do believe that they're going to do what's in the best interest for the economy and what their congressionally mandated goals and objectives are. And that's to bring inflation down and to keep the labor market going as it is. They don't want to see the labor market weaken or overheat because that in itself can bring higher inflation. 

Now, if the Fed lost its independence, that could be a big deal because they have two goals, right? And if they were to ignore those goals to do what the administration wants, that can have pretty negative consequences. And I think in the environment we're in right now, we're seeing inflation still too high. It's still sticky. It's above the Fed's target. If they were to start cutting rates right now, that could boost consumer spending. It could boost business spending. If it makes it easier and cheaper to borrow money and boost spending, that in and of itself can boost inflation because inflation, a simple way to describe it, is too much money chasing too few goods. And I think that would be a risk right now. So we don't expect the Fed to lose its independence or necessarily take cues from Trump right now.

And there is an example of this. If we go back to the '70s, Arthur Burns was Fed Chair from 1970 to 1978. And there were a lot of things going on back in the '70s. We saw inflation surge for a number of reasons. But there was an example of Nixon pressuring Burns to ease monetary policy. And he obliged when the economic conditions suggested otherwise. And then inflation did pick up.

So there is a risk, and I think that's really important to focus on now, Mike. Inflation's too sticky, and to cut rates now, that would risk having inflation stay sticky or even reaccelerate.

MIKE: Another challenge for the Fed and for bond investors generally is sorting out the implications of some of Trump's policies. I thought it was really interesting that after all the campaign rhetoric around imposing across-the-board tariffs on day one of his administration, he just didn't do that. Instead, he put out an executive order that basically directs key agencies to study the trade situation for a few weeks and report back to the White House. Since then, of course, he's made a series of public comments about imposing 25% tariffs on Canada and Mexico as soon as February 1, along with 10% tariffs on imports from China. And he's raised the idea of tariffs on imports from the European Union. We also had a bit of a rhetorical skirmish on trade issues with Colombia over the weekend. So basically, he's threatened most of our largest trading partners.

But I do think there's been a recognition that there will need to be some nuance here so as not to spark a global trade war, which of course could impact economic growth, increase inflation, raise prices for consumers. You know, as we remind our listeners every time we talk about this topic, tariffs are not paid by foreign countries. They are paid by the companies that import goods and services from foreign countries. And almost inevitably, those costs are passed on to consumers, hence the concern about inflation. Right now, we don't know exactly how the White House will employ tariffs, so the Fed, just like investors, is going to have to figure that out along the way. And I think there are other policy concerns that the Fed is wrestling with. Immigration policy could affect the labor outlook for the United States. The continuation of tax cuts and the possibility of other tax code changes also could be a factor. Tariffs, immigration, taxes. Any one of these could be inflationary, all three and it kind of feels like the Fed could really have a problem on its hands.

COLLIN: I think that it's going to be a very challenging time for the Fed right now where we have inflation still too high, as we've discussed, and now we have three policy proposals that all have an inflationary tilt to them and potentially higher interest rate tilt. So we can kind go through them one by one. If we look first at the potential for tax cuts, an extension of the tax cuts or even more tax cuts, there's two ways that that could be either inflationary or tilt towards higher yields. One, it can keep spending strong. If he cuts taxes and we have more money in our pockets, we can keep spending going, and that can keep inflationary pressures building. But also, if it results in these still-wide deficits, then that can pressure long-term yields, which is a risk that some people focus on.

Tariffs, of course, that's a wild card. You mentioned though, who pays for the tariffs? The importer pays for those tariffs, and you could argue that they're a tax. It's a higher price for the consumer if that importer chooses to pass them along. I think it's more likely than not that you'd see these companies pass along those prices rather than eating them themselves and kind of having them cut into their profit margins. So I think it's more likely you'd see higher consumer prices when we do see tariffs down the road or if we do see tariffs down the road. 

And then finally, this is kind of the wild card, is immigration, and what impact does that have? We think it can be inflationary because it can have impacts on the labor force. Just in general, if we see a large number of deportations, that's fewer people in the labor force, fewer workers, and you need to entice new workers back in to take those jobs. And then there's certain parts of the economy, certain businesses like agriculture, for example, a lot of their labor is immigrant labor. And if we suddenly don't have that, again, we need to find new workers and maybe pay higher wages to entice those workers. If you're paying higher wages, maybe you need to pass on those high wage costs to the end consumers. And maybe that ends up being inflationary as well. So we're in this environment where inflation is still here. It's been moving in the right direction, but it's still kind of stalled above the Fed's target. And now we have these three policy proposals that could result in even higher inflation. Now, we don't know the magnitude of these proposals, the timing, but they all, if you're looking to see if they're inflationary or deflationary, they're all, in our view, inflationary. So I think this is a big challenge because we talked about Trump being a low-interest-rate guy, demanding lower interest rates, but it's really hard to do that in this environment where inflation is still sticky, and it could stay sticky given these policies. So it's going to be a very interesting few months, Mike.

MIKE: Yeah, I think this is the major issue to watch over the next few months. How does the market react to the policies from an all-Republican Washington? And how does the president react to that reaction? Stock market performance is a very important metric to President Trump. I have no doubt that he will be watching carefully to see how the market reacts to his plans. And I don't think he will hesitate to modify those plans if the market starts to react negatively.

The reality is that with razor thin majorities in both the Senate and particularly the House, it's just not going to be easy to get things passed through Congress. And legal challenges to his executive orders will be fast and frequent. We've already seen his executive order suspending birthright citizenship stayed by the courts. So one of the challenges for the markets will be trying to parse out which of all the statements President Trump makes will really be a priority and then how long it will take to turn some of these issues into actual law. I think, for example, Congress ultimately passes a significant tax bill this year that extends the expiring tax cuts and maybe adds in some new ones, but I think that takes many months as opposed to weeks. 

But Collin, I wanted to switch gears here to a term that's been in the news a bit recently. Been a lot of stories about bond vigilantes, a term that hasn't been heard in recent years, and whether they are back. Bond vigilantes makes them sound colorful as well as pretty powerful.

COLLIN: Yeah, that is a pretty powerful name. The idea of the bond vigilantes, it's the idea that the market or market participants could be a check on fiscal policy. It's the idea that investors will demand higher yields given the concerns that if you have this expansionary fiscal policy with rising deficits and rising debt levels, the ability to pay those back over time. If you have consistent deficits, it means you need to keep issuing debt to finance those deficits. So it's this idea that the bond vigilantes,—thisvery powerful and colorful sounding term—would work together to demand higher yields to say, "I need to get compensated with higher yields to accept the risk of lending to someone who's constantly in deficits or issuing more and more debt."

MIKE: Yeah, I spoke at a conference recently of financial planners, and this came up, this idea that the bond market itself could act as a kind of brake on the White House overreaching on policy.

COLLIN: I want to make it clear, we think the bond vigilantes, they could be a thing, but it's not something we focus on too much. So even though I made it seem very scary, and that they're all working together, I think there's some truth to it, but that's not what we focus on. What we think drives the markets, maybe it's a whiff of bond vigilantes, but we focus more on Fed expectations, inflation expectations, growth, things like that.

But like I said, I think there could be some truth to it. In fact, we saw an example of this a couple of years ago in the United Kingdom. It was really interesting. Back in 2022, the government of the United Kingdom came out with a new fiscal plan that had large tax cuts, but no offset to spending. So how can we keep our spending going if our revenues are going down? The markets didn't really like that. And we saw the 10-year United Kingdom government bond yield, it really surged by over two percentage points. It was a really, really big increase. So it looks like it could be a thing. I don't want to brush it off, but I want to make it clear it's not something that we focus on too much. 

There is a funny quote that I want to share, and I'm sure some people might be familiar with it. James Carville said this, and I'll probably butcher the exact quote, but he said he used to think he wanted to come back as the president, the pope, or a 400 hitter in baseball. But then he said he'd rather be the bond market because you can intimidate anyone. The idea of bond vigilantes intimidating the government. Like I said, we don't put too much weight into that because we've looked into the idea in the U.S. of deficits and debt levels and what it's meant for Treasury yields.

And we just haven't really found much of a relationship. So it's tough to take that research and then say, yes, the bond vigilantes are a thing, because I think there's any number of things in a given point in time that are driving Treasury yields. That might be a small part, but again, we're focusing more on inflation expectations, expectations for Fed policy, things like that. 

But tying it all in together, I think it is going to be a risk for Trump and his administration, because if yields do rise from here, that can sort of act as a check on his policies.

MIKE: Yeah, and there's no question that debt and deficits will be front and center this year. And I think it's going to be really interesting to see how Republicans on Capitol Hill sort of square the circle between those who want to see things like tax cuts and those who are really concerned about deficits, want to see significant spending cuts, and how those two things will play out together is going to be really interesting to watch. Of course, we also have a debt ceiling debate looming in the next few months.

And there's regular conversation around how the equity markets feel about the federal deficit and a debt load of more than $36 trillion. But obviously, the bond market can't be too happy about it either. One of the concerns that gets expressed every time the debt ceiling is raised is will there still be buyers for all that debt? And if so, who is it likely to be, and what will they want in return?

COLLIN: Well, in short, we do think there will be buyers. That's not something that we're concerned with. There's a lot of things that keep us up at night, but the idea of finding buyers for U.S. Treasury securities is not one of ours. There's no shortage of potential buyers, whether it's individual investors like you and me, banks, both domestic and abroad, foreign governments, insurance companies. 

Now, there is a risk that the more debt that gets issued, you'd need to entice new buyers to come in. But we're not too concerned with that because we haven't seen that relationship really come to fruition in the past. And the idea that debt or deficit concerns would scare buyers away, we don't think that really makes much sense either because a lot of the other major developed market economies, they have similar issues with their debt and deficit, so where are you going to go if you want a country with very low debt levels relative to GDP. I mean, there's some out there, but for the large liquid markets, there aren't many. 

And finally, if we thought there was a concern by the markets, we'd probably see the dollar weaken a little bit, but that hasn't been the case. The dollar remains towards the high level of its recent range. It's pretty strong right now. A lot of that has to do with interest rate differentials, where our yields are higher than other developed-market government bond yields.

I think if there was more of a concern, we'd see a weaker dollar, and that just hasn't been the case. But Mike, you talked about the debt ceiling right now. We have a new Treasury secretary coming in. I believe he's already doing the extraordinary measures that need to be done to keep the government funded. So what's your take on that?

MIKE: Yeah, Scott Bessent, who was confirmed as Treasury secretary just on January 27, no question he has his work cut out for him right from the start. That debt ceiling clock has already started ticking down towards a potential default, and there's really no clear path forward on Capitol Hill as to how they will raise the debt limit. As you noted, the Treasury Department has begun extraordinary measures, which is a series of accounting maneuvers to prevent us from defaulting, but ultimately those are a short-term solution. So as all eyes turn towards Capitol Hill for how they're going to raise the debt ceiling, and, as I mentioned earlier, one idea under consideration is attaching a debt ceiling increase to a bill providing emergency aid to victims of the California wildfires.

We'll see whether that happens, but I do think the debt ceiling is going to be one of the trickier issues Congress will have to deal with in the coming months. Thinking about those California wildfires, Collin, it brings up another issue that's on the minds of fixed income investors, and that's municipal bonds. Holding munis in a taxable account can be a smart move for tax savings, but with those wildfires and of course last fall's hurricanes and flooding in Florida, Georgia, North Carolina, other natural disasters. It brings up concerns about how these kinds of disasters affect the municipal bond market.

COLLIN: Yeah, Mike, it's a really interesting concept that you have these natural disasters that can impact part of the bond market, specifically the municipal bond market. And for investors who are interested in this, our colleague, Cooper Howard, published an article on the idea of climate shocks, but specifically following the LA wildfires. There's a lot of really good details in there. And the impact is going to vary on each entity. There's a lot of entities in LA, not surprisingly. Things that could be at risk would be the utilities like water and power revenue bonds. Their risk is probably a little bit higher than others. Then you have the city of LA or the surrounding areas. Those could be at risk, but maybe a little bit more manageable. And then that rolls up kind of big picture to the state of California, but it seems like that's more of a lower-risk issue just given the diversification that comes with being a whole state. There's obviously a lot of different cities, towns, municipalities that make up the state. But Mike, what I think is important is these climate events are happening more and more, and they can and do have an impact on municipalities and therefore investors, whether it's hurricanes, floods, wildfires, that has an impact on actual investments.

There are some things that municipal bond investors could do, and these are kind of laid out in the article that Cooper wrote, but you could look into diversifying geographically, so you don't have all your eggs in one basket. You can maybe look for issuers that maybe are less prone to climate shocks like that. And then I think probably most importantly is focus on highly rated issuers because when something like this does happen, if you're a highly rated issuer, there's a reason you have those high ratings. You probably have strong finances. Maybe you're better able to handle things like that. Now, obviously, climate shocks, they're a shock, but highly rated issuers would be better able to handle something like that.

MIKE: Well Collin, this discussion has really put a bright light on a lot of those uncertainties in the fixed income markets and on some of the concerns that investors have right now. But obviously, we can't just turn off the fixed income in our portfolios. So I think what we need to hear is what ideas you have for us to help deal with that uncertainty. And what can we realistically anticipate as we try to keep up the so-called steady side of our portfolios steady.

COLLIN: First and foremost, you want to remember why you hold bonds. I think that's what's most important. And we always see a number of benefits with holding bonds, investing in bonds. But two of the key benefits are income and capital preservation. Where if you're investing in high-quality investments, barring default, of course, you can be reasonably confident of when you're going to get those income payments and when you'll get your money back at maturity. So I think that's really important, the idea that they could be great planning tools. But even if you see price fluctuations from when you invest to when it matures, those can be temporary price fluctuations. And what's more important are the income payments that they provide. And on the topic of those income payments, yields are still really high today. And that's what we want to focus on. And that's what we're telling our clients, whether it's Treasuries, whether it's corporate bonds, whether it's high-quality municipal bonds, yields are still near the high end of their 20-year ranges. And I think, again, that's what we want to focus on. If we look at Treasuries, for example, high-quality investment, considered one of the safest investments out there. If we're looking at short to intermediate term, say, zero to 10-year Treasury notes, you can get yields in the 4.25 to 4.75% range. I think that's really attractive in the grand scheme of things. And importantly, the slope of the yield curve is positive. What I mean by that is when you're looking at Treasuries of different maturities, as you consider longer term, longer and longer maturities, you get rewarded with higher yields. Now, slightly higher yields—if you go from a two-year to say a 10-year Treasury note, you're getting 25 or 50 basis points, or half a percentage point or so—but it still is positive. I think that's important because for most of 2023 and 2024, the yield curve was inverted, meaning you were accepting lower yields by considering some longer term Treasuries.

Now, corporate bonds, I think, are a very attractive opportunity today. In my role, I focus on the corporate bond market. I think investment grade corporates are very attractive today. When I talk about investment grade corporates, I'm talking about those with credit ratings as high as AAA down to BBB. But I'd caution that there really aren't many AAA-rated corporates left these days. Most investment grade corporates are rated either A or BBB.

But you can get yields anywhere in the 4.5% to nearly 6% area, depending on credit rating, depending on maturity. We think that's really attractive. And I think it's great for investors who have some sort of long-term plan versus the idea of sitting in a money market fund or short-term Treasury bills or short-term CDs. The idea of a short-term investment where you're kind of at the whims of the Federal Reserve and the outlook for the economy. If you're looking for more intermediate term investments, whether it's Treasuries, corporates, munis, and you can get those high yields and lock that in, you don't have to worry about what the Fed does over the next few years. 

So back to that corporate bond example of, let's say, 5% on average, I think that's really attractive to help a lot of investors reach their goals. If you think about them, what's your timeline? Can you pair that with a stock portfolio and help you reach your goal? And then municipal bonds, we think usually always make sense. We always want to focus on the tax rates, of course. What's your individual tax rate? Because if we look at the average yield of the Bloomberg municipal bond index, on the surface, it's around 3.7%. But when you look at what that taxable equivalent yield is for someone in the highest tax bracket and with high state taxes, and then once you factor in things like the Affordable Care net investment income tax, you're looking at a taxable equivalent yield of over 7%. I think that's really attractive, which goes to my final point, Mike, of which accounts you're considering these investments, whether it's a taxable or a tax-exempt account. If you're in a tax-exempt or tax-advantaged account, taxable investments tend to make the most sense because they're not taxed in there, so things like Treasuries and corporates.

And then if you are in a taxable account, take a look at what the various options are and then calculate those after-tax yields to make sure that you're maximizing your income, whether it's with Treasuries, corporates, munis, based on your tax situation.

MIKE: Well, great advice and perspective, Collin. I always learn something whenever you and I talk, and today was certainly no exception. So I really want to thank you for making the time to join the podcast today.

COLLIN: Thanks for having me, Mike. Had a great time.

MIKE: That's Colin Martin, director and fixed income strategist with the Schwab Center for Financial Research. You can follow his commentary on schwab.com/learn.

Well, that's all for this week's episode of WashingtonWise. We'll be back with a new episode in two weeks. Jeffrey Kleintop, Schwab's chief global investment strategist, will join me to discuss how the rest of the world is adjusting to the return of President Trump and the implications for international investors. Take a moment now to follow the show in your listening app so you get an alert when that episode drops, and you don't miss any future episodes.

And I'd be so grateful if you would leave us a rating or a review. Those really help new listeners discover the show. For important disclosures, see the show notes or schwab.com/WashingtonWise, where you can also find a transcript. I'm Mike Townsend, and this has been WashingtonWise, a podcast for investors. Wherever you are, stay safe, stay healthy, and keep investing wisely.