Although the U.S. recovery will enable the Fed to raise rates in 2015, long-term rates in the U.S. and other developed countries are likely to remain low and rangebound. Spread products—especially the higher yielding ones—may remain volatile, but should outperform governments by significant margins over the intermediate to long haul.
If investors looked no further than the 0.2% return on the aggregate index or the rounding error 4 basis point drop in the yield of the 10-year U.S. Treasury note from 2.53% to 2.49%, they might be inclined to dismiss the third quarter as a non-event. In fact, the quarter was rife with significant events likely to impact markets in the quarters–and perhaps years–to come.
Moderate growth, low inflation, and low money market rates should keep long-term rates rangebound and tighten credit spreads. In this environment, fixed income is likely to remain productive as an asset class, with potential returns remaining positive over the long haul and selloffs likely representing buying opportunities. Higher yielding sectors may continue to provide the highest returns.
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.