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October 23, 2012

The current market climate is challenging for those seeking yield in their portfolios, but there are yield opportunities for those who know where to look. In a recent interview, Dan Shackelford, manager of the T. Rowe Price New Income Fund and the T. Rowe Price Inflation Protected Bond Fund, discussed available yield opportunities.

Corporate Bonds Performing Strongly

Shackelford notes that corporations continue to offer bonds with returns similar to those of equities. Companies have been generating robust profits and sitting on hoards of cash and have been very conservative in terms of their decisions involving spending and hiring. These trends may not be helpful for investors that own stocks, but they enhance bond credit quality and are helpful for bond markets overall. Corporations are currently very well positioned to make good on their repayment responsibilities when issuing bonds.

Impact of QE3

The Federal Reserve Bank announced in September that it plans to purchase $40 billion worth of bonds—in the form of mortgage-backed securities—every month for as long as needed to improve the job market. This decision makes the central bank an even more important player in the bond market. It also raises questions as to how long the Fed will continue these purchases given that it is crowding out private buyers, and what the impact will be when the central bank exits the market.

Shackelford notes that these stimulus efforts, which are designed to push investors into riskier assets, could benefit both high yield and emerging market bonds. He notes that many of these bonds currently offer yields between 5% and 6% and that investment-grade securities are currently offering yield advantages compared with Treasuries that are relatively high from a historical perspective. Shackelford emphasizes that investors putting their money into either the high yield or emerging debt markets need to remember the risks, however.

Don't Forget Total Return

Shackelford notes that in an environment of continued low interest rates, bond markets have provided strong total returns in 2012 when principal gains are taken into account. For the year through September, for example, high yield bonds have provided returns of 11.2% and investment-grade corporate bonds have generated an 8.7% gain.

Investment Outlook

Shackelford notes that the global economy is facing persistent challenges, with a lackluster recovery in the United States and an economy in Europe that is either flat or leaning toward a recession. With interest rates already low, economic weakness isn't likely to result in additional price gains for bonds, though it should further postpone future interest rate increases.

Shackelford points out that it is very difficult to get returns of between 8% and 10% in the current investing climate, but more moderate returns are still possible. That will likely continue to be the case for the next few years. He recommends that market participants incorporate securities into their portfolios that will benefit from an improving economy even if inflation ticks up modestly.

Yield and share price will vary with interest rate changes. Investors should note that if interest rates rise significantly from current levels, bond fund total returns will decline and may even turn negative in the short term. There is also a chance that some of the fund's holdings will have their credit ratings downgraded or will default. Deflationary conditions (when inflation is negative) could cause the Inflation Protected Bond Fund's principal and income to decrease in value.

The views are as of October 4, 2012 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.

Copyright 2014, T. Rowe Price Investment Services, Inc., Distributor. All rights reserved.