‘No Fooling, Good Quarter for Bonds’: LPL Strategist

Q2 Outlook

Valeri points out that the nearly 2% quarterly return for the Barclays Aggregate Bond Index is not a sustainable pace.

"Simple math would put the current pace on track for a high-single-digit return for the full year, a very difficult achievement for a still low yield environment," he cautioned.

For bond prices to continue to rise and yields to fall, the markets would have to see one or two things happen: Persistent lackluster economic data and a Fed pause in tapering its bond purchases.

Neither scenario is likely.

"We expect economic data to improve and believe the odds of both outcomes above are low," the LPL report noted. "The Fed has additionally indicated that a reduction in bond purchases will continue, and it is unlikely to alter course absent a significant shift in the economy."

Still, lower-rated sectors of the fixed-income universe, such as high-yield bonds, should offer yields to buffer the impact of rising rates, Valeri adds. With an average yield spread of 4%, however, high-yield bond prices don't have much room to improve further, and the LPL Financial fixed-income team expects interest income to be "the primary driver of returns over the balance of 2014."

Valeri says the 3.5% Treasury-yield level appears to be "an important market signal," as a drop below that mark would indicate that the bond market sees greater economic concerns.

Overall, Valeri says, bond prices and yields may remain in their longstanding range until May (when more economic information is published). A repeat of the first-quarter performance "is unlikely," he adds.

"We continue to favor lower-rated bonds," Valeri stressed. "Although additional price gains for lower-rated bonds may be limited, higher interest income may help deliver a performance edge over the remainder of 2014."