Rising rates have pushed bond indexes into the red this year, but high-yield bonds, helped by tightening credit spreads in energy, have bucked the trend.
Rising interest rates have pushed fixed income indices into negative territory year to date. The longer end of the curve has risen the most, as the 5-year U.S. Treasury has only risen 14 basis points to 1.79%; whereas, the 10-year has risen 31 basis points, and the 30-year Treasury has risen 46 basis points with those two bonds currently yielding about 2.5% and 3.2%, respectively.
As you would expect with their higher duration, long-term bonds have been the worst performers this year. Our Long Term Government Bond Index has dropped almost 4%; whereas, our Short Term Government Bond Index has increased 36 basis points.
As rising rates have pushed bond prices down, this has erased the amount of yield carry that bonds have generated thus far this year. For example, the Morningstar Core Bond Index, our broadest measure of the fixed-income markets, has declined a half of a percent year to date. Within this broad index, sub-indices such as our Government Bond Index has lost 0.8% and our Investment Grade Corporate Bond Index has declined a little over 1%.
However, in the high-yield sector, while the Bank of America Merrill Lynch High Yield Index gave back some of its gains from earlier this year, it still remains up 3% year to date. The gain has been driven by a combination of tightening credit spreads, as the average credit spread of the index tightened 44 basis points to +460 basis points over Treasuries, as well as the higher carry that wider credit spreads afford.
In our first-quarter outlook published late last year, we made our case on why we expected the high-yield market to outperform investment-grade this year. However, we note that much of the outperformance has probably already been captured as a significant portion of the credit spread tightening in the high-yield market has occurred in the energy sector. As oil prices recovered from their lows earlier this year. The average spread in the energy sector tightened 107 basis points, and currently stands at a spread of 650.
We continue to expect that high yield will provide a better return than investment grade as the high-yield segment has a much lower correlation to underlying interest rates than investment-grade bonds and is more dependent on economic conditions. While GDP contracted in the first quarter, Robert Johnson, our director of economic analysis, continues to expect moderate economic growth in the U.S. this year of between 2% to 2.5%. This level of growth should be enough to hold down default rates, which in turn will support the high-yield market.
