With Treasury Yields So Low, Should Investors Look to Corporate Bonds?

As the second round of quantitative easing comes to an end this month, investors eagerly await the next FOMC meeting to be held June 22-23, 2011. Data released last week showed continued job losses and the slowest growth in manufacturing activity in over a year. The sluggish increase in wages and reduced confidence in the economy has kept the housing market in the doldrums, despite low mortgage rates and relatively easy borrowing.

Although the fate of the third round of quantitative easing is unclear, one thing is for certain – the Fed will remain committed to keeping interest rates lower, at least until the end of this year. The 2-Yr Treasury note yields only 0.43%, while the benchmark 10-Yr note yields 3% - 18 and 35 basis points lower respectively compared to the beginning of the year. The graph below shows how the yield curve has flattened this year. The front end of the yield curve seems to have priced in the worst and does not have much room to drop further, but the rally can surely extend further along the curve.

So does it mean that the 5-10 Yr T-bonds are a good investment? Probably not. The real yield on the 10-Yr for example is merely 0.76%, while the real 5-Yr yield is negative. It might be a good trade in the short term, but not an attractive investment.

With Treasuries yielding very low rates for so long, investors have shifted their focus to corporate bonds. Although not considered as safe as Treasuries, investment grade debt is an attractive asset class for those who have not yet found their long lost confidence in riskier assets. And ETF’s (iShares Barclay’s etc) are a good alternative that not only allow buying in smaller chunks at low transaction costs but also provide the advantage of diversification (not to mention easy shorting). An annual yield of about 2.5% is hardly exciting but it is far better than the 0.5% offered by two-year treasuries.