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By Dave Sekera, CFA | 04-08-2014 10:00 AM

Have Bonds Already Peaked for 2014?

Due to the Fed taper and expected rise in interest rates, corporate-bond investments likely have little room to grow for the remainder of the year.

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Dave Sekera: Thus far this year, the Morningstar Corporate Bond Index has generated a 3.36% return. This return is really going to be based on carry, tightening within corporate credit spreads, and declining interest rates.

Now breaking it down a little bit further, interest rates have driven most of the gains. For example, the average yield on the 10-year Treasury bond has dropped 30 basis points and is now at 2.7%.

Within the corporate bond market, within the past couple weeks we have seen corporate credit spreads tighten. For example, within our Corporate Bond Index, the average spread is now 110 basis points, which is 10 basis points tighter than where we ended at the end of last year.

And then finally, the amount of yield carry has generated the rest of the return, and the current yield on our bond index is about 3% right now.

However, I really do think that we've probably generated most of the gains that we will see this year for corporate bonds. And the reason is that we do think that interest rates will rise over time, and we do think that as the Fed reduces its asset-purchase program, rates will start normalizing toward where they should be compared with historical metrics--for example, inflation, inflation expectations, and so forth. And so from this point, we do think that the 10-year [Treasury yield] could rise about 50 basis points.

And then finally, corporate credit spreads have tightened. They've tightened 10 basis points, but most of that has really come just in the past couple of weeks. Really there's a technical factor behind that. So what we've seen is that there have been a lot of asset flows into the corporate-bond market; however, the new issue market has slowed significantly during the past couple weeks.

We're now entering into what's called the quiet period before earnings, and companies are keeping themselves out of the market until they report. Once they do report, we expect the new issue market will open back up, and as that new supply comes into the market that should be able to satiate the amount of demand that's out there, such that we expect corporate spreads should hold in the same level that they are now or may even widen just a little bit.

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