Yields near record lows while signs of rising recession risk create a dilemma
This year’s global debt rally has left some investors wondering if the biggest gains are in the rearview mirror.
U.S. government debt has returned 7.8% this year through Thursday counting price changes and interest payments—well above the 2.2% average for the previous 10 years, according to Bloomberg Barclays data. This year’s 13% gain in corporate bonds for that period is more than twice the 6.1% average since 2009, while high-yield debt has appreciated 11%, roughly matching its 12% annual average for the same period. The S&P 500 is up 17% for that period.
Now, some investors are concerned that bond prices have risen so much that they have little room to increase further. Boosted by an unusual combination of steady economic growth and Federal Reserve rate cuts, the yield on the benchmark 10-year Treasury note—the percentage investors expect to earn annually from buying the bonds—now stands around 1.7%, within 0.4 percentage point of its all-time low. Yields fall when prices rise.
At the same time, the extra yield investors demand to hold both investment- and speculative-grade corporate debt instead of relatively safe Treasurys stands near multiyear lows.
For Treasurys to notch further gains, the economy will likely have to show new signs of deceleration, some investors say. That could hit corporate and junk bonds, which investors tend to sell in times of economic weakness. The reverse is also true: A surge in growth that boosts corporate bonds would likely dent gains in Treasurys.
“This is the quandary for taxable [bond] investors like ourselves,” said Bryce Doty, a bond manager at Sit Investments. “I’ve been telling my customers this just isn’t sustainable.”