Tuesday, May 10, 2022
The unrelenting move higher in U.S. Treasury yields continued last week with the yield on the 10-year Treasury up another 15 basis points (0.15%). Moreover, 10-year Treasury yields have doubled this this year with 130 basis points (1.3%) of that 150 basis point increase in yields coming since March 3. Last week’s increase in the 10-year Treasury yield was the 14th week (out of the last 18 weeks) where yields ended the week higher. To say it’s been a challenging year for fixed income markets is a huge understatement.
“The opportunity set for core bonds has improved greatly this year,” noted LPL Financial Fixed Income Strategist Lawrence Gillum. “Core bonds, in general, have been pretty expensive over the past few years but are much more attractive at current levels. The universe is trading at deep discounts to par so the potential for price appreciation is the highest it’s been in decades.”
However, fixed income instruments are fundamentally different than other financial instruments. Bonds are not only tradable securities but are also financial obligations where the issuer is contractually obligated to return principal at or near par at the maturity of the bond. That is, if an investor holds a bond (or a portfolio of individual bonds) to maturity, bond issuers are obligated to pay back par, regardless of the interest rate and inflationary environment. So, while this year has certainly been challenging, we do think the investment landscape has improved as current prices for many fixed income securities are trading at deep discounts to par.
As shown in the LPL Chart of the Day, the average price of a bond within the Bloomberg Aggregate bond index is less than $93, which is the largest discount to $100 par price in more than four decades. And while it is more common for non-investment-grade rated securities to trade at such deep discounts to par due to the higher probability of default, these are high quality securities with an investment-grade rating and with low expected default rates. Currently, nearly 82% of the universe of core bonds trade below par. Moreover, the average price of a U.S. Treasury security within the Aggregate index is $92.29—and it is a near certainty that the U.S. government will honor its financial obligations and pay back its debt at par.
Over the long run, the contribution to the total return for most fixed income investments depends more on coupon income than on changes in price. Since 1976, just over 90% of the average annual return of the U.S. bond market has come from interest payments and the reinvestment of interest payments. The big price moves we’ve seen this year are certainly unusual but may present an opportunity for price appreciation along with common interest payments.
This material is for general information only and is not intended to provide specific advice or recommendations for any individual. There is no assurance that the views or strategies discussed are suitable for all investors. To determine which investment(s) may be appropriate for you, please consult your financial professional prior to investing.
Investing involves risks including possible loss of principal. No investment strategy or risk management technique can guarantee return or eliminate risk in all market environments. For more information on the risks associated with the strategies and product types discussed please visit https://lplresearch.com/Risks
References to markets, asset classes, and sectors are generally regarding the corresponding market index. Indexes are unmanaged statistical composites and cannot be invested into directly. Index performance is not indicative of the performance of any investment and do not reflect fees, expenses, or sales charges. All performance referenced is historical and is no guarantee of future results.
Unless otherwise stated LPL Financial and the third party persons and firms mentioned are not affiliates of each other and make no representation with respect to each other. Any company names noted herein are for educational purposes only and not an indication of trading intent or a solicitation of their products or services.
All information is believed to be from reliable sources; however, LPL Financial makes no representation as to its completeness or accuracy.
Tracking # – 1-05277718