At current yields, a 10-year bond's coupon income can offset mark-to-market losses from a 100-basis-point rate increase within a year. This "margin of safety" makes them attractive buys, a principle that fails for longer-duration 30-year bonds due to higher risk.
Instead of hiking short-term rates, the Fed may follow Japan's lead by letting long-term yields rise. This "stealth steepening" devalues currency, boosts exports, and helps manage government debt, creating a favorable environment for banks that profit from a steeper yield curve.
BMO views an AI-driven recession as a distant risk (2028+). More pressing concerns are a sudden oil price spike to $150/barrel, amplified by depleted reserves, or a wider Middle East conflict that forces inflationary, inefficient spending on war efforts.
BMO is poised to buy energy bonds not for capital appreciation, as they are already tightly priced, but as a strategic hedge. In an economic downturn caused by a sharp oil price increase, the strong cash flows of energy companies would make their bonds a top performer.
The massive debt offerings from AI companies are absorbed by insurance companies, whose buying power is fueled by Pension Risk Transfers (PRTs) from corporations with overfunded defined benefit plans. An uptick in PRTs will sustain the market's appetite for long-dated AI bonds.
A clear sign of market saturation from AI debt is spread compression across credit ratings. Top-tier issuers like Microsoft (AAA) are seeing their bonds trade with spreads just one notch better than lower-rated peers (BBB), indicating excess supply is flattening risk premiums.
Rather than holding cash or T-bills, BMO parks capital in highly liquid corporate bonds with maturities under two years. This tactic provides attractive 'roll down' yield and serves as a ready source of funds to quickly pivot into higher-risk assets when spreads widen.
BMO is highly optimistic about U.S. economic growth, citing business deregulation and forthcoming lower bank capital requirements as key drivers. The only major event the firm believes could derail this positive outlook is a significant, direct escalation of the war in the Middle East.