Rising rates led to a difficult first quarter for fixed income, but the silver lining is that income opportunities may have improved. Another dynamic that is affecting the income landscape is the flattening of the yield curve. The yield curve is a line that plots the interest rates, at a set point in time, of bonds having equal credit quality but differing maturity dates. A flatter yield curve resulting from short-term rates rising faster than long-term rates indicates that investors aren’t demanding much additional compensation to loan their money for longer periods. This can be a benefit to investors searching for yield, but who are concerned about the impact of rising interest rates, because, as LPL Research Chief Investment Strategist John Lynch explained, “At this time, a flattening yield curve is giving investors more yield with less interest rate risk at shorter maturities.” Please see our LPL Chart of the Day below:
As of April 27, 2018, a 5-year Treasury note yielded 2.80%, while a 10-year note yielded 2.96%. Investors can essentially cut their interest rate sensitivity in half, while only sacrificing 0.16% in yield. Similar opportunities exist in other sectors, like investment-grade corporate bonds. For instance, the Bloomberg Barclays Corporate 1–3 Year Index yielded 3.08% as of April 27, 2018, its highest yield since October 2009 and a meaningful yield with limited rate sensitivity. The yield curve is giving investors opportunities for income, while defensively positioning their portfolios against the possibility of rising interest rates.
For LPL Research’s top ideas for income-generating strategies, please see our Bond Market Perspectives, “Search for Income: Yield Opportunities Improve.”
Treasuries are a marketable, fixed-interest U.S. government debt security. Treasury bonds make interest payments semi-annually and the income that holders receive is only taxed at the federal level. Treasuries are subject to market and interest rate risk if sold prior to maturity.
Yield curve is a line that plots the interest rates, at a set point in time, of bonds having equal credit quality, but differing maturity dates. The most frequently reported yield curve compares the 3-month, 2-year, 5-year and 30-year U.S. Treasury debt. This yield curve is used as a benchmark for other debt in the market, such as mortgage rates or bank lending rates. The curve is also used to predict changes in economic output and growth.
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