How attractive is the yield environment today relative to recent history?

For much of the past decade, fixed income yields were exceptionally low by historical standards, held in check by Fed policy and low inflation. That changed dramatically over the past year, as surging inflation and the Fed’s aggressive rate tightening rapidly lifted yields. The resulting slippage in bond values last year may have dampened investor enthusiasm for fixed income, but the outlook for bond investors has dramatically improved as expected returns have risen.

As shown above, yields for both taxable and tax-exempt bonds are near their highest levels of the past 15 years. Increased yields raise expected returns over the long-term, improve their diversification benefits versus equities, and enhance the income-generation potential of a portfolio. Compared with just a few years ago, each of these benefits have become more pronounced as the yield curve has shifted higher.

It’s important to realize that not all fixed income investments are alike, nor are they all influenced by the same factors over the course of a cycle. Notably, despite their higher yields, credit sectors such as high-yield corporates don’t appear to be as attractively valued today, given the considerable uncertainty related to the economic outlook and potentially growing default risk that would almost certainly result in a widening in credit spreads, pushing yields upward. And while cash yields are also relatively attractive today, core bonds may deliver more compelling total returns over the next phase of the cycle as we discuss in our accompanying piece.

The bottom line? Despite last year’s disappointing returns, high-quality bonds are more attractive today than at almost any point over more than a decade. In time, credit will also have its proverbial day in the sun, but investors should be careful about reaching for yield in this environment.