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Bonds in the Second Quarter: The Flattening

Despite a Fed rate hike, most Morningstar bond categories showed gains.

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Nearly every taxable-bond Morningstar Category posted a positive return for the three months ended June 30 as credit spreads tightened and the yield curve flattened.

The Fed and the Flattening Yield Curve
Long-term bonds did well last quarter as the yield curve flattened. The short end of the curve shifted up as the Federal Reserve raised interest rates in June for the second time this year, but investor appetite for Treasury bonds pushed the longer end of the curve down. The Fed also announced plans to reduce the size of its balance sheet--meaning it would stop reinvesting coupon payments and eventually begin selling bonds--but the market largely shrugged at the news. The yield on the 10-year finished the quarter at 2.31%, down 9 basis points from the end of March. This dynamic was especially helpful for funds with super long durations, such as  Vanguard Long-Term Investment-Grade (VWESX) and  PIMCO Long Duration Total Return (PLRIX) whose 13- and 14-year durations, respectively, pushed both funds’ returns up 5.0% and 4.7% for the quarter. Those funds’ long durations, however, are not the norm for their categories and can cause wide performance swings.

Cara Esser does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.