Bond investors this year have shed much of the abject fear that gripped them in the fourth quarter.
The result was that most categories of bond mutual funds posted gains in the first quarter as bond prices either rose or didn't fall enough to negate their interest earnings.
The exception: funds that focus on U.S. government bonds. They had been a favored hiding place during the market and economic calamity of the fourth quarter. But as fears have eased this year, some investors have been dumping government bonds, driving their prices lower and yields up.
Record government borrowing also has pushed Treasury yields higher as new bonds have flooded the market.
For other popular bond sectors, including tax-free municipals and high-yield corporate (junk) debt, first-quarter winnings provided many diversified investors with an offset to more stock market losses.
Jeffrey Gundlach, chief investment officer at L.A.-based money manager TCW Group, parent of Trust Co. of the West, says the wild sell-off in financial markets in the fourth quarter amounted to a massive "repricing" of risk. In the bond market, that meant investors suddenly demanded far higher yields on most types of bonds to compensate for the unknowns of a crashing economy.
With that repricing, "The 'mega-risk' has been taken out of the credit markets," Gundlach says. In other words, investors in the first quarter were more comfortable that bond values weren't likely to collapse again.
Instead, buyers were lured back to many types of bonds in the new year thanks to last year's surge in yields.
Funds that own muni bonds, for example, posted total returns of 2% to 6% in the quarter ended March 31, on average, according to Morningstar Inc. Total return counts interest earnings plus or minus the net change in principal value.
It helped the bond market that the Federal Reserve continued to hold short-term interest rates at record lows, just above zero. That drove some investors to push cash into bonds in search of higher interest income.
But for financial markets overall, it's far from certain that the first quarter tells us much about what's to come this year -- or beyond.
One threat has disappeared for the time being but could come roaring back: the risk of rising inflation, which would erode fixed-income returns and could send interest rates soaring.
