Bond Yields Are Falling. Where Retirees Can Still Find 5% Yields.

Retirees may need to look beyond U.S. bonds as the Fed cuts rates. (Dreamstime)

Key Points

About This Summary

• Bond yields are declining on expectations of a Federal Reserve rate cut next week.
• Investors can still find nominal yields around 5% and inflation-adjusted yields of around 2% in high-quality corporate bonds.
• Consider quality intermediate-term bonds, as the economy shows signs of weakness and the inflation outlook is mixed.

Bond yields have edged down on expectations of a Federal Reserve rate cut next week, and they may drift lower if the economy sours. If you need income from your portfolio, it may be time to start making adjustments.

The Fed has kept its benchmark rate on hold since December, at a range of 4.25%-4.5%. But there is now a 90% chance of a quarter-point cut at the Fed’s next policy meeting on Sept. 17, according to market futures. In anticipation, the two-year Treasury note hit a 52-week low of 3.5% on Monday, down from about 4% in June. The 10-year Treasury yield is flirting with 4%, its lowest yield since the “Liberation Day” market rout of early April.

Meanwhile, rates on money-market funds have shrunk from roughly 5% to 4%. Between that and lower Treasury yields, the “risk-free” income that retirees have enjoyed for the past few years is waning.

“The free lunch is kind of coming to an end,” says Jack McIntyre, global fixed-income portfolio manager at Brandywine Global Investment Management.

Replacing bond income may involve taking on more risk, so pause first to assess your needs. If your income is no longer keeping up, look for inflation-adjusted “real yields” that can protect your purchasing power. Those yields are still available in many areas of the bond market, in good measure because the Fed has kept rates much higher than they were before inflation spiked in 2022.

While rates are coming down, investors can still find nominal yields around 5% and inflation-adjusted yields of around 2% in high-quality corporate bonds, says Adam Abbas, a co-manager of the Oakmark Bond fund, which is ahead 7% this year and yields around 4.6%.

Another way to invest is through a low-cost exchange-traded fund such as iShares 1-5 Year Investment Grade Corporate Bond . It yields about 4.3% and is up 5.6% this year on a total-return basis.

Be careful about dicier parts of the market. Lower-quality “junk bonds,” for instance, yield around 6.5%. But that isn’t much additional yield over Treasuries, based on historical spreads—meaning that investors aren’t being rewarded much for taking the additional risk of holding bonds from companies that are vulnerable to economic downturns. Approach high-yield bonds with caution in this environment, experts say.

Consider sticking to quality intermediate-term bonds. The economy is showing signs of weakness, with job growth slowing and the impact of President Donald Trump’s tariffs unclear. The inflation outlook is mixed; some experts argue that tariff-related price increases will be transitory, while others say they will last longer.

Inflation weighs on bonds, since it erodes the purchasing power of their income. The longer end of the yield curve is more sensitive to inflation expectations. If investors are worried about stubborn prices, they will push prices down on longer-dated bonds, sending yields up.

Instead of venturing out on the curve to pick up incremental yield, it’s safer to stick to maturities of about three to seven years, bond pros say.

The Vanguard Intermediate-Term Corporate Bond ETF, for instance, yields 4.9% and is up 8% this year. It has a rock-bottom expense ratio of 0.03%.

Another option: foreign bonds. The dollar’s decline has been a tailwind for such issues, which are worth more when translated from their local currency into dollars. To get this “currency kicker,” look for a fund that invests directly in local-currency bonds rather than hedging all the currency exposure back into the dollar, BrandyWine’s McIntyre says.

The fund he co-manages, the BrandywineGlobal Global Opportunities Bond fund, fits the bill. It has about 60% of its portfolio in the U.S., with the rest in developed and emerging markets. It yields about 5.7% and is up 13.5% in total this year.

Among ETFs, SPDR Bloomberg International Corporate Bond has been a strong performer, up nearly 16% this year in total. While it only yields about 2.6%, price and currency gains have fueled its returns. The fund has about 20% of its assets in the U.S. and 50% in European markets such as the United Kingdom, France, and the Netherlands.

Whether to go with an active or passive fund is debatable. While actively managed bond funds have struggled this year on tariff-related turmoil, there are still some solid choices. Vanguard Multi-Sector Income Bond, for one, holds a little bit of everything, investing across countries and credit types, and yields around 4.3%. The ETF launched only this year, but it is based on a mutual fund with an average annualized return of 7.8% over the past three years, beating its benchmark index.

Write to Elizabeth O’Brien at elizabeth.obrien@barrons.com