With yields on the 10-year Treasury Note recently touching two percent for the first time since April 2012, bond investors are expressing concern. But moderately rising rates are not necessarily a bad sign, at least not for the private economy, and may be a positive for high-yield and emerging market fixed income investors, according to Fran Rodilosso, Fixed Income Portfolio Manager at Market Vectors ETFs.
“The rise in yields appears to reflect a general belief, right or wrong, that the underlying economy is strengthening, the surprise drop in fourth quarter GDP notwithstanding,” said Rodilosso. “For me, it would be more frightening should yields return to their prior low levels, a sure sign that the U.S. economy is dragging again, or as a result of a disruptive economic event in Europe, China, or elsewhere that shakes global confidence.”
Rodilosso noted that “spread product” – bonds that tend to trade in relation to 10-year Treasury yields – began reacting to the higher yield environment this week. This includes both investment grade and high-yield corporate debt. “The spreads on investment grade debt are historically tight, but I think high-yield paper may have at least a small amount of spread cushion remaining,” Rodilosso said. “Credit quality could improve in a growing economy, so the corporate debt world, which overall is far healthier than the U.S. government, still warrants investment consideration in my view.”
While Treasury yields could retreat again, the Market Vectors Portfolio Manager believes fixed income investors who have not already done so should start to consider hedging their bets as the market moves towards a more normalized “risk free” Treasury rate.“There are various ways to adjust a fixed income portfolio – reducing interest rate duration, adding floating rate exposure or inflation-linked notes, for example,” Rodilosso said. “I am also an advocate of local currency emerging markets debt, based on stronger fundamentals of some of those countries and their currencies exhibited at the sovereign level and the fact that most of those borrowers are still paying interest rates that are not artificially low.”