Morningstar - Q2 2021 - 33

Low Yields, Low Expectations
Why intermediate core bond investors
should be cautious in this environment.

CORE BONDS

Gabriel Denis

Intermediate core bond funds are traditionally
the centerpiece of an investor's fixed-income
exposure, but they aren't as attractive as
they used to be. At the beginning of 2008, the
typical intermediate core bond category strategy
yielded around 4.5%. Through the tumult
of the global financial crisis, the subsequent bull
market, and the coronavirus-related recession
of 2020, this figure dropped to 1.2% by the end of
February-the lowest it had been since at
least March 1990 (the earliest that we have SEC
yield data).1 It has since rebounded slightly
but is still near historic lows.
Given that bond yields move inverse of bond prices,
this yield compression is the result of a bull
market for bond funds, wherein price appreciation
has contributed to sizable gains for many
participants over the period. But because yields
across the fixed-income market are as low as they
are, price appreciation will likely play an even
smaller role in the typical core bond fund's total
return today than it has in the past.

FOMC hiked rates on and off from 2016 through
2018, the federal-funds rate again sits near zero
after being slashed in the wake of the coronavirusrelated economic downturn of 2020.

These rate cuts, as noted by the St. Louis Fed,
have the most direct effect on short-term interest
rates and a more muted effect on long-term
rates. This effect can be seen in the movements
of various parts of the U.S. Treasury yield curve
since 2008 ( EXHIB IT 1 ).

explores the answers to these questions,
but there are no easy solutions.
Fed's Role
Yields have been falling in the fixed-income
marketplace over the past several decades but
especially since the global financial crisis
of 2008. While there are a number of reasons for
this, one pertinent actor in this drama is the
U.S. Federal Reserve. In response to the crisis,
the Federal Open Market Committee slashed
the federal-funds rate, the interest rate on which
depository institutions trade balances with
each other overnight, close to zero in early 2009
and kept it there until late 2015. While the

Both the three-month and one-year Treasuries
have closely followed rate cuts and hikes
from the FOMC over the period, with each yielding
around 3% at the beginning of 2008 while
yielding close to zero at the end of February
2021. While longer-dated Treasuries do not follow
short-term interest-rate movements in lockstep,
their yields have also dropped over the
same period, as demand for U.S. Treasuries has
remained high over the past several years.
The 10-year Treasury, which is often used as
a barometer for the fixed-income market, began
2008 yielding 3.9% and ended the period
yielding 1.4%, falling below 1% for much of

EXHIBIT 1

Effect of Fed Rate Cuts Short-term Treasury rates have more closely followed
the Fed's cuts than have longer-term Treasuries.
U.S. Treasury Rates

3 Month

1 Year

10 Year

30 Year
5%
4

Moreover, according to research by Morningstar's
David Blanchett, there is a strong relationship
between current bond yields and 10-year
bond returns.2 Therefore, today's low yields don't
bode well for long-term returns.
How did we get here and how should investors
navigate this low-yield environment? This article

2.17

1.44 2
0.08 1
0.04 0
01/02/2008

01/02/2011

01/02/2014

01/02/2017

02/26/2021

Source: Morningstar. Data as of 02/28/2021.

1 In March 1990, funds reported SEC yields ranging from 6% to 8%.
2 Blanchett, D., Finke, M., & Pfau, W.D. 2013. " Low Bond Yields and Safe Portfolio Withdrawal Rates. " The Journal of Wealth Management, Vol. 16, Issue 2, PP. 55-62.

morningstar.com/lp/magazine

http://www.morningstar.com/lp/magazine

Morningstar - Q2 2021

Table of Contents for the Digital Edition of Morningstar - Q2 2021