Fixed Income Looks Attractive Again
For ETF investors, the key issue is not simply whether bond yields look high, but which part of the fixed-income stack is being purchased. Treasury ETFs, intermediate-duration funds, corporate bond funds and high yield all respond differently when rates rise, inflation expectations shift or risk appetite weakens. A higher starting yield can improve the opportunity set, but the mix of duration and credit exposure determines how much of that yield is exposed to price volatility.
Duration remains the main brake on near-term bond price stability. Even when yields appear attractive, longer-maturity holdings can still be sensitive to further moves in real rates and inflation expectations. Investors using bond ETFs as ballast should pay attention to whether the portfolio is designed to dampen equity drawdowns or to harvest yield. That distinction matters because the same rate move can have very different effects across short, intermediate and long-duration strategies.
Credit quality is the second layer of risk. Tight spreads can support corporate bond ETFs, but they also leave less compensation for unexpected deterioration in earnings, financing conditions or refinancing costs. In practical terms, investors may prefer to separate core rate exposure from credit exposure rather than assume one broad bond fund solves both objectives. Rebalancing back to a target mix can also help avoid drifting into more spread risk than intended after a strong rally in risk assets.
For long-term portfolios, fixed income works best when its role is explicit:
- income generation
- equity hedging
- liquidity reserve
- inflation-aware diversification
That framework is often more useful than debating whether bonds are universally โcheapโ or โexpensive.โ The real decision is how much rate sensitivity and credit risk an investor is willing to own in exchange for current income.
Real Yields Approaching 2%, Appear Attractive Again
Most investors focus on nominal yields when purchasing bonds because, as we have reiterated over the years, โyield matters.โ Typically, the starting yield of a bond is the return that the investor will receive if they hold the bond to maturity. While the nominal yield is important, the โrealโ yield (nominal yield minus implied inflation) is crucial as it calculates the true increase in purchasing power of the investment. Chart 1 above compares nominal yields and real yields back several years prior to the Great Financial Crisis (GFC) in 2008.
While real yields have averaged nearly 1% over the last 23 years, (the dotted red line in the chart), it has been a story of 3 regimes. From 2003 to 2010, and now in the post COVID world the average has been around 2%. By contrast, to prevent deflation after the GFC, the Federal Reserve ensured that both short- and long-term interest rates were below the rate of inflation, making bonds unattractive in our opinion. With real yields back around 2%, we see opportunities.ย Hence, bonds are attractive again in our opinion.
Credit Spreads Likely to Stay Tight, Due to Strong Corporate Earnings
While we view real yields as an important indicator of the attractiveness of bond valuations, we also view credit spreads (the risk premium paid to own corporate bonds rather than Treasuries) as an important input. When credit spreads are โtightโ compared to Treasuries (meaning investors require a smaller risk premium than normal to own bonds), this indicates that investors are confident that companies can meet their debt obligations. When credit spreads are โwideโ versus Treasuries, this suggests less confidence in their creditworthiness. Currently, credit spreads both in investment grade corporates (bonds rated BBB or higher) and high yield corporate bonds (rated BB or lower) are trading exceptionally โtightโ, near their all-time lows as shown in Chart 2, above. High yield and investment grade risk premiums are 2.77% and 0.81% respectively above comparable maturing Treasuries. High yield credit represented by the left axis and investment grade risk by the right axis in Chart 2. Strong corporate balance sheets have kept investorsโ appetites for bonds robust, leading to solid availability of credit. We believe that credit spreads will remain in a tight range for the remainder of the year, barring a global macroeconomic event, as corporate earnings in the US remain strong.
Conclusion: Bonds Are Offering Real Value Again; Look to Lock in Higher Yields on Inflation Concerns
We expect the bond market yields to face upward pressure the remainder of 2026, as the fallout from the Iran war will keep oil and gas prices elevated for an extended period. The combination of elevated oil and gas prices will put upward pressure on inflation via higher transportation costs passed along the supply chain into finished goods prices. Higher inflation will bring worries of stagflation to the forefront, causing bond yields to rise further, in our opinion. However, we believe that there is a ceiling on how high yields can go because higher inflation will slow the economy down and cause Fed officials to lower interest rates. Hence, we believe upside resistance for the 10-year Treasury in a stagflation scenario is around 5%โฆa level that would likely trigger significant demand from yield-seeking investors and slow economic activity enough to be self-correcting. Given a Kevin Warsh-led Fed will likely have a bias towards cutting rates, we do not believe the central bank will wait for yields to move that high. We view the oil and gas inflationary impulse as temporary and thus seek to take advantage of opportunities if yields move meaningfully higher than current levels.Enjoyed this article? Sign up for our newsletter to receive regular insights and stay connected.