Bond yields are low across the board





Today, bond investors are in a bit of a quandary. Global bond yields are extremely low, depriving yield-thirsty investors of income.





As of January 21, the 10-year US Treasury yield stood at 1.77%. Investment-grade bonds and even high yield bonds are not offering attractive yields. A bunch of European sovereign bonds is still trading at negative yields, which is ridiculous!





Low yields are a consequence of loose monetary policies in the developed world. Stubbornly low inflation and slow growth particularly in Europe and Japan have led to constant, aggressive monetary stimulus, leading to negative yields.

















Bond yields remain low despite rising inflation





While bond yields are higher in the US, signs of rising inflation have not caused a meaningful rise in bond yields yet. Increasing or high inflation usually comes with higher bond yields. The Fed could let inflation overshoot a bit before hiking rates.





The US corporate investment-grade bond yields across all maturities are hovering close to their all-time lows. US corporate high yield bonds are also not yielding attractive yields, albeit higher than Treasury and investment-grade bonds.





However, we are now late in the credit cycle, hence junk bonds, especially with low yields, is laden with a risk. Investors are not being adequately compensated for the risk they are taking in high-yield bonds.





Holding both riskier bonds and Treasuries together could improve risk-adjusted returns





Holding junk bonds along with Treasuries, though, would improve risk-adjusted returns, as Treasuries act as a ballast, and junk bonds provide higher income.





This is prudent because equities face several headwinds including geopolitical tensions, frothy valuations, and slow growth. US Treasuries and equities have a negative correlation.





Interest rate risk or duration is higher for bonds with longer maturities as they are more sensitive to change in interest rates.





In the US the spread in yields between long-maturity bonds and those with shorter maturity bonds is quite low. That is, the yield curve is pretty flat.





Hence, holding on to intermediate and short maturity bonds may seem to be more advantageous as the yield per duration risk is higher in such bonds.





However, as mentioned above, equities and other risk assets face several headwinds. In such a backdrop holding duration may be warranted.

















European bonds have a steeper yield curve relative to the US





Even though European sovereign bonds are trading at negative yields, the difference in yields between long-dated bonds and those with short maturities is higher compared to the similar spread in the US.





Hence, one could take on interest rate exposure in Europe, given the steeper yield curve, and the uncertain economic and geopolitical outlook.





While the investor may not be rewarded with income via this strategy, returns through price appreciation are still possible.





The flip side however, is that if the economy and inflation show even some sign of improvement these bond yields would back up quite a bit!





Emerging market bond yields have declined





Meanwhile, emerging market debt has had a good run since 2019. While yields are more attractive compared to developed market bonds, the spread has compressed over the years.





Economic growth, as well as earnings, in major Asian emerging markets like China, India, Indonesia, and South Korea have been slowing. Hence, any risk-off scenario could cause an emerging market debt sell-off. Higher oil prices could also affect these economies given that they are net importers of crude oil.





High-dividend sectors like utilities and staples are dubbed as bond proxies. However, these sectors are trading at over 20x trailing-twelve-month earnings, which is rich considering that they are broadly slow-growing sectors.





Bottom line





The bottom line is that finding yield in today's market has become difficult. Hence the bond investors either have to settle with the possibility of price appreciation alone or buy credit assets at much higher risk compared to earlier.





The US economy seems to be in a relatively solid footing. However, uncertainties hover over US equity markets, which may mean investment-grade bonds, especially Treasuries, could add ballast to the portfolio.





Update:





The outbreak of coronavirus is the last thing the Chinese economy wanted. The fear of the virus spreading and slowing down the global economy has already caused 10-year Treasury yield to fall to 1.68%.