What Do Credit Markets Think About Higher Rates?

The 10-year Treasury yield recently surpassed its March 2017 post-election highs due to a  combination of higher global rates (driven by more hawkish central bank expectations), rising growth expectations tied to tax reform, and an increase in inflation expectations. Yields on investment-grade and high-yield bonds have also risen, but not to the same degree as Treasury yields. This has caused spreads for both investment-grade and high-yield bonds to trade at their lowest levels since the current expansion began.

Rates remain low relative to history, but expectations of higher short-term rates (due to Federal Reserve policy) and higher longer-term rates (driven by economic growth and inflation outlooks) can cause investors to worry that higher borrowing costs for consumers and businesses could cause a slowdown in growth—though concerns seem to be muted thus far. In fact, markets are currently showing few signs of stress as seen in the chart below.

John Lynch, Chief Investment Strategist commented, “We continue to believe investment-grade corporate bonds, even at tight current spreads, offer value relative to Treasuries. High-yield bonds can also help provide additional income where appropriate, though their higher exposure to credit risk warrants a smaller allocation in most cases.” To learn more about what tight spreads could mean for investors, as well as our views on investment-grade corporate and high-yield bonds, please see the latest Bond Market Perspectives, “Bond Market Not Stressing About Higher Yields”.

 

IMPORTANT DISCLOSURES

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance referenced is historical and is no guarantee of future results.

Any economic forecasts set forth in the presentation may not develop as predicted and there can be no guarantee that strategies promoted will be successful.

All indexes are unmanaged and cannot be invested into directly. Unmanaged index returns do not reflect fees, expenses, or sales charges. Index performance is not indicative of the performance of any investment.

Investing involves risk including loss of principal.

Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values and yields will decline as interest rates rise, and bonds are subject to availability and change in price.

Corporate bonds are considered higher risk than government bonds but normally offer a higher yield and are subject to market, interest rate, and credit risk as well as additional risks based on the quality of issuer coupon rate, price, yield, maturity, and redemption features.

High-yield/junk bonds (grade BB or below) are not investment-grade securities, and are subject to higher interest rate, credit, and liquidity risks than those graded BBB and above. They generally should be part of a diversified portfolio for sophisticated investors.

Government bonds and Treasury bills are guaranteed by the U.S. government as to the timely payment of principal and interest and, if held to maturity, offer a fixed rate of return and fixed principal value. However, the value of fund shares is not guaranteed and will fluctuate.

Option-Adjusted Spreads (OAS) represent the difference between the index yield and the yield of a comparable maturity Treasury. The OAS can be used to measure the risk levels markets are placing on high-yield bonds.

Yield spread is the difference between yields on differing debt instruments, calculated by deducting the yield of one instrument from another. The higher the yield spread, the greater the difference between the yields offered by each instrument. The spread can be measured between debt instruments of differing maturities, credit ratings and risk.

This research material has been prepared by LPL Financial LLC.

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