May 3, 2012
|Andrew McCormick, head of T. Rowe Price's active taxable bond team and manager of the T. Rowe Price GNMA Fund.|
Bonds have had several years of strong performance as interest rates have fallen to historic lows and investors increasingly seek out securities with a yield advantage over Treasuries. But can this streak continue with interest rates at rock-bottom levels? Andrew McCormick, head of T. Rowe Price's active taxable bond team and manager of the T. Rowe Price GNMA Fund, encourages investors to keep their high yield return expectations in check and seek income from additional fixed income sectors while being mindful of Fed actions and the potential for artificially low interest rates to rise.
- High yield bonds have returned more than 5% year-to-date*—a torrid pace that is difficult to continue—but we are still investing in them.
- High yield issuers have balance sheets that are better than ever before, and their bonds are currently yielding about 600 basis points** (six percentage points) more than Treasuries.
- Bank loans, which are senior to equities and traditional fixed income securities in a company's capital structure, currently offer 5.5% to 6.0% yields.*** Due to their floating rate features, these securities will yield more if interest rates rise—a benefit for those concerned about rising rates.
- Corporate bonds in emerging markets have a better long-term growth trajectory than those in the developed world.
- CMBS have an attractive credit structure, and we are adding to our holdings as Federal Reserve sales of some holdings acquired during the 2008 financial crisis increase supply in the market.
- Corporate balance sheets are in tremendous shape, as companies have taken advantage of low interest rates in recent years to shore up their balance sheets. In contrast, balance sheets of sovereign governments in the developed world have been deteriorating.
- Corporate issuance, which was brisk over the last few years, is expected to be low this year and flat on a net basis. This has reduced the yield advantage of corporate bonds over government bonds.
- Policy actions by the Federal Reserve and other central banks can lead to market volatility, and we are always mindful of interest rate risk.
- Yields on U.S. Treasuries have been kept artificially low by Fed purchases and increased demand from risk-averse investors amid global uncertainty.
- We believe interest rates could rise modestly this year as markets begin to anticipate the reversal of the Fed's accommodative monetary policies.
- However, if inflation or economic growth picks up unexpectedly, rate hikes may occur sooner than late 2014.
- If the employment picture continues to improve, we believe the Fed would prefer to let this program of selling shorter-term Treasuries and buying longer-term Treasuries end as scheduled.
- However, the Fed is likely to assure investors that it would resume buying Treasuries in the event of weaker U.S. growth or an external shock to the economy.
** JPM Global High Yield Index STW as of 4/27: 659 bps.
*** S&P/LSTA Leveraged Loan Index Yield as of 4/30: 6.01%
Bonds are subject to credit risk and interest rate risk. High yield bonds have a greater risk of default than higher quality bonds. Unlike many fixed-income securities, Treasury bonds are guaranteed as to the timely payment of principal and interest. Investors should note that if interest rates rise significantly from current levels, bond fund total returns are likely to decline.
The views are as of 4/25/12 and may have changed since that time. This information is provided for informational purposes only and is not intended to reflect a current or past recommendation, or investment advice of any kind.
Opinions and commentary do not take into account the investment objectives or financial situation of any particular investor or class of investor. Investors will need to consider their own circumstances before making an investment decision.