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Morningstar Minute: Muted Returns From Corporate Bonds Ahead

Fri, 7 Mar 2014

The corporate bond index will struggle to return more than the 2% it already has this year given the likelihood of rising long-term rates and today's historically low credit spreads.

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Video Transcript

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Dave Sekera: The Morningstar Corporate Bond Index currently yields about 3% right now and has a six-year average duration (a measure of interest-rate sensitivity). Based on that, the credit spread inherent within that yield is about 117 basis points over Treasuries. Now at 3%, we're a little bit higher than the 2.5% where it bottomed out last year in May, and so it's a little bit better for investors. However, compared with a 15-year average of about 5.25%, it's still very low on a historical basis.

Thus far this year, the index has returned about 2%. However, we would caution that a lot of this return has actually been based on the underlying interest rates, decreasing. For example, the 10-year Treasury has gone from 3% back down to 2.75% providing that return. Corporate credit spreads, however, are largely unchanged this year. Although the Corporate Bond Index has risen 2% thus far this year, we think that it's going to struggle to return much more over the rest of the year. 

We're looking at a couple of different things. One, we do think that interest rates, and specifically long-term interest rates, will end up rising over the long term. We're looking at probably 3.5% to 4.0% being more of a normalized value for the 10-year yield as the Fed continues to taper its asset-purchase program, its quantitative easing program, and really, we're just looking at a more normalized level as far as where Treasuries should trade versus inflation, inflation expectations, and our expectations for gross domestic product growth.

In addition, with the corporate credit spread on average being 117 basis points in our index, that's essentially the lowest level we've seen since the 2008-09 credit crisis. Based on that, we think that the corporate bond market has probably garnered a significant portion of the returns that it's going to get for this year.

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