- Bond rallies driven by global uncertainty have pushed yields on US Treasurys to historical lows.
- This has made it difficult for fixed income investors to find returns in the market without taking on high amounts of risk.
- While there are a few opportunities left in corporate debt, investors don’t expect yields to go back up anytime soon.
- Read more on Markets Insider.
The rally in bonds continued Wednesday, sending the yield on the 30-year Treasury bond to a new low of 1.9% just a day after it dipped below 2% for the first time ever.
Elsewhere along the yield curve, the 10-year note fell to 1.4% on Tuesday. That extended the inversion between it and two-year notes, which was already the widest since May 2007.
What’s driving the bond rally yields fall when prices rise is “a general flight to quality in a more uncertain environment,” Bill Lawrence, chief investment officer of traditional asset management at SEI, told Markets Insider in an interview.
Global trade conflicts, political turmoil from Hong Kong to Argentina, and concerns about Brexit are all driving that uncertainty, he said. Bond yields fall when prices rise.
The overall situation has created a couple of issues for fixed income investors now struggling to find solid returns in an environment where yields are low all around. First, yield curve inversions are recession indicators – one has preceded every recession since 1950 – and this has increased investor panic. That, in turn, has driven the bond rally further and dragged yields lower.
Second, negative yields in Europe and Japan also make US treasuries look more attractive to international investors, even when the yields are historically low for the US. That’s put even more downward pressure on yields.
Don’t write off bonds even though yields are low
“It’s certainly scary when you see yields fall so sharply, and when you see the yield curve inverted,” Collin Martin, managing director of fixed income at Charles Schwab told Markets Insider in an interview.
For bond investors, it “makes it difficult to earn higher yields and earn higher income. And it can get frustrating,” he added.
Still, Martin says it still makes sense to consider the five- to 10-year part of the yield curve. This is because it’s expected that the Federal Reserve will lower interest rates, which could send short term yields lower in the future. Thus, locking in yields in the middle of the curve makes sense.
“It’s almost like a blink and you missed it and you could be rolling your treasuries back to zero in a few years,” Martin said.
There are a few opportunities
To be sure, chasing the flight to quality is not appealing to all investors.
“We’d rather look for relative values among things that have underperformed recently,” Lawrence said.
Even though the options are slimmer, there are some opportunities to enhance the yield of a portfolio if you pick carefully, said Lawrence.
“Investment grade corporate bonds, even in a weaker economic environment, can still offer an opportunity,” he said.
He added that historical default rates are still relatively low, and would likely stay low even through a downturn.
In addition, Lawrence likes structured products including agency mortgage-backed securities, automobile and credit card receivables, and even other types of commercial mortgage-backed securities.
“You can get fairly high credit quality and these are sectors that still offer pretty good liquidity,” he said.
But increased risk isn’t for everyone
With all of that established, it’s worth noting that higher-yield assets bring increased risk with them that could be too much for some investors to stomach. While corporate bonds – especially high-yield ones – can look attractive in a low-yield environment, Martin says to tread lightly.
The relative yields, even in high yield, are pretty low right now, he said.
“It’s actually difficult to call it a high-yield bond today when you’re only getting a yield of 5% or 6%,” he said. Thus, investors are getting lower yields with rising risks.
If an investor does have high-yield or investment grade corporate bonds in their portfolio, Martin says to watch risks at the lower level of the investment grade market, specifically the growing amount of companies ranked BBB, the lowest rung. If the economy does slow, those corporate bonds would be at high risk of slipping into junk territory.
“In the meantime, we think it’s prudent to move up in credit quality a little bit,” he said.
Finding the right balance of risk to reward might not get easier anytime soon. This is because of the amount of negative-yielding debt around the world, as well as the fears about global growth and trade concerns, he said.
Even if the Federal Reserve were to cut interest rates at their next meeting, it is unlikely to drive long-term yields much higher, Martin said.