Barring a sustained upside surprise in growth, 2014 is shaping up to be a productive year in bonds. The combination of low growth, moderate inflation, and low short-term interest rates, should continue to fuel the search for yield. The strongest returns are likely to accrue to the highest yielding sectors over the balance of the year.
While global economic prospects are better, the recovery remains fragile and uneven, likely keeping short rates low and long rates contained. As investors search for yield, 2014 should be a better year for bonds than 2013, with the higher yielding sectors and those hardest hit in 2013 offering the best potential.
While volatility could remain high as the Fed approaches the end of its buying program, we believe both Treasury yields and spreads have overshot fair value. While perhaps counterintuitive, the economic recovery may have once again created significant opportunities in the bond market.