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Where to Find Opportunities in Fixed Income Today

Look to investment-grade financials and industrials, TIPS, and--assuming the economy holds up--high-yield bonds and leveraged loans, says Fidelity's Ford O'Neil.

Emory Zink: Hello, I'm Emory Zink for Morningstar. Joining me today is Ford O'Neil from Fidelity Total Bond (FTBFX). Thank you for joining us, Ford.

Ford O'Neil: It's great to be here, Emory.

Zink: In 2015, the broad fixed-income market produced meager returns. Where are you looking for opportunities in 2016?

O'Neil: Emory, I would argue that returns are probably more modest, and I think people have to get used to that. When you think about where yields are and where spreads are today, lower-single-digit returns, I think, are going to be with us for a time. But I also think there are areas of opportunity as well as opportunities to outperform the marketplace. We like investment-grade credit. We think there are a lot of opportunities in financials, and there are also some specific industrials that we like today. TIPS we also think are quite attractive. We are probably a little more upbeat on higher CPI readings later this year--I think those are attractive. And lastly, we think CMBS--commercial mortgage-backed securities--are a very attractive sector, especially if you need shorter-term instruments.

Zink: I know that Total Bond has an allocation to high yield. There was a severe sell-off there during the fourth quarter of 2015. Are you looking to add to that position?

O'Neil: We think that high-yield bonds and also leveraged loans are both very attractive. We are strongly in the camp that believes the U.S. economy will continue to muddle along--similar to the way it's been muddling for many years now. We're not heading into a recession. I think the high-yield marketplace and leveraged loans as well are starting to imply that there is much higher potential for recession. Our view is that once high-yield-bond spreads are breaching 600 to 700 basis points, historically that's been a really nice buying opportunity. So, as long as you are not in the recession camp, we think they are both attractive--both loans and bonds.

Zink: And another question that's on everybody's mind: What will the Federal Reserve do? What's your outlook for Fed policy in 2016?

O'Neil: We are probably a little more optimistic than the markets today. The markets are implying one or two hikes in the next year to two years. Again, if we're right on the U.S. economy getting better in the second half of this year, we think the Fed will be back on a very, very slow, very gradual hiking process. And again, with unemployment now below 5%, it's hard to imagine that the fed funds would remain at 25 basis points. But clearly, they are also struggling with very low CPI and PCE readings, and obviously volatility in the marketplace isn't helping their cause either. But we would expect some Fed hikes in the second half of this year.

Zink: Ford, thank you for joining us.

O'Neil: Thanks for having me in.