With short-term bonds getting most of the fanfare during the Fed’s aggressive rate hiking cycle, more investors are looking to long-term bonds again. This is especially the case as interest rates fall amid Fed easing.
Morningstar is positing that while rate cuts appear to be a foregone conclusion, it won’t happen swiftly. Rate cut forecasts by Morningstar peg the federal funds rate to fall to 2.00%–2.25% by the end of 2026. This is where long-term bond holders can reap the benefits of price appreciation over time.
“Should our fed-funds rate forecasts play out, investors would benefit by holding longer-term fixed-income bonds to maintain higher income levels,” Morningstar noted. “For example, the 10-year Treasury yield stands at 4.3%. If we assume a 1% term spread (the difference between shorter- and longer-term bond yields to account for the risk of longer-term investments), that implies an expected average fed-funds rate of 3.3% over the next 10 years. By contrast, we expect the fed-funds rate to average 2.3% over the next 10 years.”
One interesting note that Morningstar mentioned in their research is the still relatively large number of investors who are holding cash. To add an additional dose of intrigue, it’s primarily investors who remained on the sidelines following the stock market disruption in 2020, when the COVID-19 pandemic upended major indexes.
“According to the Investment Company Institute, money market (cash) fund assets rose to $6.51 trillion as of Oct. 23, 2024,” Morningstar highlighted. “A further look at net monthly US money market fund flows highlights that investors have not unwound large cash hoards after the height of the covid pandemic.”
As the old adage states: no risk, no return. Such is the case for investors still holding cash where they could be invested in assets like long-term bonds that can maximize their opportunities.
“Consequently, longer-term government bonds appear to offer an attractive total return opportunity relative to cash deposits,” Morningstar added.
An Ideal Long-Term Play
Fixed income investors opting to get long-term bond exposure can do so easily with the Vanguard Long-Term Bond ETF (BLV ). It seeks to track the performance of the Bloomberg U.S. Long Government/Credit Float Adjusted Index. It includes all medium and larger issues of U.S. government, investment-grade corporate, and investment-grade international dollar-denominated bonds with maturities of greater than 10 years which are publicly issued.
As mentioned in its product description, BLV is mainly comprised of investment-grade debt, with half coming from U.S. Treasuries. As such, credit quality is of the highest caliber, with no holdings falling below BBB. The majority of the fund (about 37.8%) holds debt issues that exceed over 25 years. To add to its diversification and decrease concentration risk, the fund has over 3000 bonds in its portfolio.
The fund’s 30-day SEC yield is at 4.98% as of December 6. Furthermore, BLV features a low expense ratio of 0.04%.
For the full suite of Vanguard’s fixed income ETF products, click here.
For more news, information, and analysis, visit the Fixed Income Channel.
