Bond Yields Rise Sharply While Corporate Spreads Remain Low Amid Middle East Tensions

The bond market has experienced a significant shift in recent months, with yields rising sharply after a prolonged period of historically low returns. Yaron Friedman, head of research at Bank Leumi's investment division, explains that while bonds may seem less glamorous than stocks or derivatives, they remain a crucial portfolio anchor due to their predictable yields.

This surge in yields is most evident in U.S. government bonds, traditionally viewed as the world's safest asset. However, Friedman attributes the primary cause to geopolitical developments in the Persian Gulf. Prior to the recent conflict, oil prices hovered around $60 per barrel amid declining inflation and central bank rate cuts. The outbreak of war and Iran's effective closure of the Strait of Hormuz caused oil prices to double to $120 per barrel within weeks, sparking inflation fears.

This shift reversed the global interest rate narrative. Central banks in Europe and Japan have already begun raising rates, with the UK signaling similar moves. The U.S. Federal Reserve has yet to act, possibly due to the new chair's cautious approach, but bond markets have preemptively priced in higher yields worldwide. Rising government bond yields increase corporate borrowing costs, though in Israel, high-grade corporate bond spreads remain relatively low at 0.6%-0.7%, offering yields around 4.5% or more.

Friedman highlights two main profit drivers in bonds: the steady yield received if held to maturity and potential capital gains if rates fall later. He anticipates that once the conflict ends, oil prices and inflation will ease, prompting central banks to cut rates again and generating capital gains for bondholders, a rare opportunity in recent years.

For individual investors, Friedman recommends two main approaches: direct corporate bond purchases, which require active management and incur taxes and fees on coupons, or investing through mutual funds or ETFs, which offer diversification, reinvestment of interest, and tax deferral. He advises evaluating fund fees, underlying assets, credit ratings, and sector exposures to select suitable instruments. The Tel Aviv Stock Exchange currently provides a wide range of bond investment options to meet diverse investor needs.