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Don't Expect Much From Your Bond Holdings

Dave Sekera, CFA

Dave Sekera: As expected, the Federal Reserve reduced its asset-purchase program by another $10 billion this week. As the Fed lessens the amount of intervention in the market, we expect that interest rates will continue to rise over time such that they should normalize toward more normalized rates compared with inflation, inflation expectations, and general economic growth. As such, we figure that should put the 10-year Treasury around 3.5% over the long term.

Since the rally in Treasury bonds in January, Treasury bonds have traded in a very narrow range over the past 12 weeks, and in fact, the 10-year Treasury has been range-bound between 2.6% and 2.8%. Taking a look at that historically, over the past 20 years, this is the first time it's been in such a narrow trading range for that amount of time. In fact, just taking a look over the same time frame, there's only been a couple instances in which the Treasury has been range-bound within 30 basis points, much less a 20-basis-point range.

In this low-volatility environment, corporate credit spreads have been able to grind in over the past 12 weeks, as well. Right now, the average spread within the Morningstar Corporate Bond Index is 107 basis points over Treasuries. Just to put that in context, if we look at the past 15 years, it's about 50 basis points tighter even excluding after Lehman Brothers filed bankruptcy and credit spreads really blew out. However, when I do take a look at it, there's about 27 basis points tighter that the index could still go; however, I don't really expect to see it to get that tight again. There are a number of different factors that occurred back in 2007; there were a lot of structured products which artificially pushed credit spreads tighter at that point in time.

With interest rates either staying here or possibly going up a little bit through the rest of the year, with credit spreads really being about probably where they should be right now, we suspect probably the best investors really can hope for in corporate bonds or at least investment-grade corporate bonds for the rest of this year is the current yield of 3%.