Yields have languished at historic lows and are slowly beginning to rise, but the demand for bonds has remained quite high ever since the credit crisis of 2007-08.
And why wouldn’t the demand be high when the following drove investors to bonds:
- Investors’ fears of equity markets in the 9+ year bull market
- Non-U.S. central banks maintained a healthy cushion of current account reserves
- Open market operations by the Federal Reserve Bank (i.e., “quantitative easing”)
- A very accommodative monetary policy
As demand for bonds has soared, the yield plummeted. As every student of finance knows, the yield on bonds is inversely related to its price. While the Fed eventually started a policy of tighter monetary conditions, the overhang from a nearly a decade of loose monetary policy still haunts the market.
This has left bond investors with an unattractive set of options:
- If rates stay low, bonds are unlikely to generate enough income to meet their spending needs.
- If rates increase, current bond holdings are susceptible to losses in value.
Looking at the current interest rate environment and the long-term credit cycle, the road ahead for bond investors, as well as, for traditional 60/40 portfolio construction is challenging indeed.
An Inflection Point for the Bond Market?
Source: Swan Global Investment, St. Louis Federal Reserve, Organization for Economic Co-operation and Development (OECD), Shiller, www.econ.yale.edu/~shiller/data.htm: 10 year U.S. Treasuries 1926-2018. The 60/40 portfolio refers to 60% Ibbotson US Large Stock Inflation Adjusted Total Return and 40% Ibbotson US IT Government Inflation Adjusted Total Return USD.