Surge in 'risk-free' treasury yields sends bond investors in search of better opportunities

On Friday, the 10-year U.S. treasury yield was at 4.57% while the 30-year treasury bond was up to 5.08%. The shift in bond market assumptions is a wake-up call for investors in an asset class that has long been called a "safe haven" due to bonds' predictable income and guarantee of the return against maturity. HSBC wrote in a note this week that U.S. treasuries are now in a " danger zone." U.S. treasury bonds typically occupy a special place in an investor's portfolio — the asset class against which all other market risk is measured. But a surge in long-dated yields is forcing investors to rethink this assumption. CHICAGO - MARCH 28: Traders in the Ten-Year Treasury Note options pit at the Chicago Board of Trade signal offers in a flurry of activity following the announcement by the Federal Open Market Committee that it was raising short term interest rates another.25 percent March 28, 2006 in Chicago, Illinois. Trading in the pit was at a trickle in the moments leading up to the announcement. The raise was the 15th consecutive increase by the Fed and the first since Ben Bernanke took over as chairman of the FOMC. JoAnne Bianco, senior investment strategist at BondBloxx Investment Management, voiced similar concerns on CNBC's "ETF Edge" podcast this week. "You are calling it the risk-free rate. It is not risk free. There is a lot of risk associated with this," she said. "Now the next likely action is they are going to be raising rates at some point, potentially starting later this year," she said. The bond market action leads Bianco to make two recommendations for fixed income-focused investors. While a higher yield offers investors more income, it also punishes bond prices. Bianco suggests investors focus on the intermediate part of the treasuries curve, specifically the 5-year to 7-year range. That part of the bond market lets investors "step in at these higher rates" without the price volatility that has punished holders of long-dated bonds, she said. She also recommends investors look to opportunities in the bond market that reflect the underlying strength of the U.S. economy and corporate earnings within the investment grade and high yield markets. While it is true that corporate bonds spreads are tight, Bianco said, "they are tight for a reason." Corporate fundamentals and recent earnings are strong and many companies in both the investment grade and high-yield market have issued positive guidance. Within investment grade, Bianco says BBB-rated corporates stand out as the best opportunity, and that is nothing new, she added. During almost any time period, "the coupon income advantage that you get from BBB bonds" has driven complete outperformance versus both the broad U.S. corporate index and the U.S. aggregate bond index. In corporate bonds, income is the dominant driver of total return and BBBs carry a yield premium over high-rated investment grade bonds. An income premium comes with a higher degree of default risk, but she said while default risk is an issue investors should always be aware of, the current market environment does not suggest to her there is reason for elevated concern at this point in the economic cycle. With issuer fundamentals currently strong, she says investors are getting the income premium "without the material increase in default risk" that many assume comes with the territory. She noted that default risk in the BBB segment of the investment grade market, while higher than AAA, is very low — under 0.3% over the past 30 years. The high-yield market, meanwhile, where yields are as high as 12%, currently features strong average credit quality, as well as strong corporate earnings and business fundamentals from issuers. Bianco noted many issuers are focused on their leverage ratios and interest coverage, and there is more focus on refinancing in the market than on speculative on M&A and leveraged buyout issuance, with the latter having moved more to the private side of the bond market. "The market is open for companies to refinance and we expect defaults to be well below the long-term average through the rest of the year," Bianco said. Sign up for our weekly newsletter that goes beyond the livestream, offering a closer look at the trends and figures shaping the ETF market. Disclaimer