U.S. Fixed Income: 40-Year High Starting Yields

We anticipate that the yield on the 10-year U.S. Treasury bonds will fluctuate within the range of 3.8% to 5.0%, and it will not return to the low levels seen in recent years.

This creates a favorable environment for bond investors, with starting yields that are quite attractive, indicating that future returns will also be more substantial.

Currently, the yield on the 10-year U.S. Treasury bonds has surpassed the stock yield of the S&P 500 index, making the risk-adjusted returns of bonds more appealing.

Bonds have historically been a good risk buffer, providing stable positive returns even during significant stock market declines.

Investors now have the opportunity to lock in high starting yields that have been rare over the past decade.

After a strong rebound in interest rates in 2023, the upward trend temporarily flattened in the first half of 2024, but yields remain high.

Several major central banks around the world have started a rate-cutting cycle, and the Federal Reserve has begun to lower interest rates, boosting market confidence.

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Against this backdrop, we continue to be optimistic about fixed-income assets and believe that the current time is an attractive entry point.

The fixed-income market has seen significant discounts, with the prices of U.S. investment-grade bonds falling close to the lowest levels in over four decades.

Considering the high correlation between starting yields and expected returns over five years, we believe that the current market environment provides a rare opportunity for investors to capture high yields, enhancing the potential for total returns as bond prices gradually return to par value upon maturity.

In the current environment, the risk and return of asset allocation have become more balanced.

It is worth noting that the yield on the 10-year U.S. Treasury bonds has now surpassed the stock yield of the S&P 500 index, making the risk-adjusted returns of bonds more attractive.

Historical experience shows that whenever central banks pause rate hikes, the risk-adjusted returns of bonds tend to be quite substantial.

Taking the Federal Reserve as an example, the average annual return on investment-grade corporate bonds within three years after it paused rate hikes is about 8%, comparable to the 9% return on U.S. stocks, but with less than half the volatility.

Additionally, when central bank policies shift to maintaining interest rates or start cutting rates, the correlation between stocks and bonds is usually low.

Bonds have historically been a good risk buffer, providing stable positive returns even during significant stock market declines.

As geopolitical risks increase, market volatility may intensify, highlighting the importance of diversifying investments in bonds.

Investors now have the opportunity to lock in high starting yields that have been rare over the past decade.

Looking forward, we believe that bonds can not only provide higher total returns but also act as a buffer during stock market adjustments.

In an environment of economic slowdown, central banks may significantly cut interest rates, thus the sustainability of cash returns is relatively low.

The 10-year Treasury bond yields of the U.S. and Germany may remain high.

Emerging market local bonds have higher spreads and potential for price appreciation.

Persistent macroeconomic and geopolitical uncertainties will create abundant opportunities for investors, who can enhance investment value through bond issuance, industry selection, term structure, and currency allocation.

The 10-year Treasury bond yields of the U.S. and Germany, as the main sources of returns, are likely to continue to remain high.

We maintain a relatively cautious attitude towards directional forecasts because the current environment presents two-way risks: the upward risks posed by a resurgence of inflation and fiscal risks, and the downward risks posed by a slowdown in inflation and economic recession.

The investment-grade credit spreads in the U.S. and Europe have narrowed, and compared to the compression of spreads, spread trading is more likely to become a source of returns.

Spread dispersion and macroeconomic volatility will also present opportunities for active asset managers, especially when credit yields are generally high.

Macroeconomic uncertainties, quality, fundamentals, and valuation differences bring opportunities for hard currency bonds in emerging markets.

With emerging market central banks still having room to cut interest rates, local bonds in emerging markets have higher spreads and potential for price appreciation.

As the Federal Reserve cuts interest rates, yields will continue to fall, providing investors with a brief window to extend duration and lock in higher rates.

The spreads of high-yield bonds have approached fair value, but a deeper analysis reveals that the dispersion in this area has reached the highest level in decades.

We believe that the market has underestimated global geopolitical risks and uncertainties, thus creating opportunities for active investors to increase risk and return through selective credit.

In the new market environment where bond yields are rising, fixed-income assets are highly attractive to long-term investors.

Given the rise in bond yields, a more favorable risk-reward profile compared to stocks, and the potential for capital appreciation as interest rates decline, the current fixed-income market offers investors an excellent opportunity to enhance the potential for total portfolio returns.