Why this portfolio manager is bullish on bonds

Yield pulling back from 14 month highs on the heels of this morning, softer than expected inflation. But we weren't too far from that 5% level. But as of right now, the 10 year yield right around 4 64. So here with more on today's reaction and also how to best play the bond market through E. T. S. We want to bring in Steve McPhee. He's Vanguard senior portfolio manager joining us now as part of today's ETF report sponsored by Invesco QQQ. Steve, it's great to have you on here. I'm curious what you make of today's dramatic reaction to the inflation print we got this morning and what this means here, what the signals for bond market investors who are trying to play this through ETFs. Good morning. Thanks for having me on. Um, yeah. So let's start first of all, with with Vanguard's core philosophy, and that is we're bullish on bonds. We see bonds having a special moment. It's the type of moment where you want to march to the rooftop and shout down to investors by bonds and to paint the story to tell the story. We've got to go back to the fourth quarter of 23 and look at the environment. That's when peak that's when yields peak last in October, and we hit that 5 10 and 30 years. We hit that 5% very briefly in 10 year U. S. Treasuries. That happened because inflation was running at a double digit pace. We had uncertainty in the global economy. Central banks were trying to get their arms around the situation and put stability back in the system. Fast forward 15 months later, like you were saying, we've got the same level of yields all of a sudden, but inflation has a two handle. The Federal Reserve has landed the plane per se. Things have stabilized. The picture is much rosier in the U. S. We have U. S. Exceptionalism, and it is alive. But again, yields are high. That means bonds are an opportunity. Like you mentioned, we briefly hit a 5% here in the 30 year in the last few days. We had a slight tick down in CPI today of a 10th of a percent, and all of a sudden we have a 14 basis point rally intense. So I think the market realizes for cheap and it reacted and it dip by it was buying the dip pretty ferociously. When you take into account the extent of a move like we are seeing here this morning, is that something that's going to be almost like the new normal here for bonds as we do get to this place here of a little bit more certainty? I think investors need to look through the noise. Look past the noise. Let an expert like myself, a professional worry about the day to day oscillations of the market. Really, our message is there's a special opportunity here for investors to lean further into fixed income, and I'm gonna Vanguard geek out a little bit here and channel my inner Jack Bogle. Jack would say stick with your program and program is synonymous, synonymous with your investment allocation based on strong U. S. Equity returns in 23 and 24, which were double digit sizes. You're probably leaning too heavily in equities. Your portfolio is probably bulging too far in that direction, and it's thirsty for bonds. So as a recommendation, buy bonds, allocate the bonds, but let a professional like myself deal with the day to day volatility. Steve, I think the question investors are asking is what's the best way to do that, right? There's so many different ways to invest in the bond market right now, whether you're going on the long side, the short side. Where are you seeing that opportunity? Sure. I mean, first and foremost, we really don't care if it's mutual fund ETF passive or active. Just get it in there. But we are seeing a preference for ETFs. That doesn't mean there's any tension between mutual funds and ETFs of Vanguard. Our mutual fund business is bustling, but there's the preference building for ETFs. 10 years ago, that was 10% of 80 a U. M. A Vanguard. Today, it's 30%. And I think there's really three reasons why the preference in ETF is building. The first is pretty easy. It's pretty historical, and that's the fact that you have intraday liquidity, minute by minute liquidity, push of a button liquidity. The second, which is evolving, is around taxation. The ETF in-kind redeem mechanism will wash away any capital gains. Any unrealized capital gains are in the portfolio. So you can minimize gains, and you can reduce capital gains in the ETF wrapper. And the third is more new, and that's around advisors really focusing on tax loss harvesting. And that really exists in an open architecture ease of access environment where these advisors can do as many trades as they want or need ETF with no gates or restrictions like a traditional mutual fund might have. Steve, what have flows looked like so far this year for you? Flows are robust. I mean, we're fortunate here at Vanguard. They're usually robust, but they're extra heavy and fixed income, active and passive. I can speak to munis in particular. The muni market in 2024 had the fifth best inflow period into mutual funds and ETFs going back to the early 90s. On our desk, the muni active desk, we're a market leader with $200 billion in assets. We traditionally take about 20 to 25 cents in every dollar. We had that same pace last year. The big change we are seeing is flows are actually going into short duration products for the first time in two years. With the Fed easing several times, they're pushing front money markets out the curve into ultra short and short duration. But importantly, we are still getting flows into high yield, long term, intermediate and state specific products. So it's broad and robust. All right, we'll see what the trend continues. Steve, thanks so much.