With bond yields back above 5%, are bonds attractive again?

With the 10-year Treasury note back above 5%, the assumption that the “40” in a 60/40 portfolio is an afterthought is being tested. Are bonds attractive again? Partly. Bonds are back as an income and relative-value asset. They are not yet back as the portfolio's shock absorber.

The case for the "40" is the strongest it's been in a generation

Start with the math: what investors are paid for equity risk over bonds. The implied equity risk premium has fallen to roughly zero, about -0.4%, unseen since the late 1990s, while the Shiller cyclically adjusted price-to-earnings ratio sits near 40.6, matched only in 1929 and 2000. Fixed income now offers roughly the same forward-looking return as equities in a balanced portfolio, with far less downside if valuations normalize: our model implies roughly a 40% decline for the S&P 500 Index should the equity risk premium revert to its 2.0% long-run average.

Equity Risk Premium has collapsed below zero, just as in the late 1990s

Yield is not the same as safety

A 5% yield may look good on paper, but consider that the high yield reflects rising credibility risk, not growth. The 10-year Treasury yield broke above 5%, its highest since 2007, even as the Federal Reserve raised rates, pointing to a rising term premium, not stronger growth. Treasury debt's free float has grown to roughly 54% of GDP, a post-war record, leaving private buyers to absorb $2 trillion of new issuance a year. Our model implies 17 bps a year of upward drift in the term premium, plus 15 to 35 more from artificial intelligence-related issuance, so coupon income can still erode on long duration.

The hedging role is what's in doubt

The real question is whether bonds will do their job when equities fall. The Federal Reserve is tightening after cutting into inflation, as in 1973, 1977, 2000 and 2022, years when equity returns averaged -4.8% the following year. In the inflation-driven versions of that regime, 2022 above all, bonds fell alongside stocks rather than cushioning them. With the diesel strip implying a producer price index above 4% into spring 2027, inflation remains the dominant risk, arguing against relying on duration to offset a drawdown this time.

Credit is not a substitute for Treasuries here

Investment-grade credit yields are in the mid-5% range, but caution is warranted: roughly 86% of that yield is simply the government rate, spreads sit at all-time tights, and CCC-rated spreads have widened all year, a late-cycle warning sign. 64% of this year's duration-weighted issuance comes from the AI complex, so owning credit is largely a second bet on the same theme equity portfolios lean on. We remain cautious on credit and see value in credit hedges.

Positioning: take the yield, but keep duration moderate

Our conclusion is not to avoid fixed income but to rebuild it with intent: capture today's elevated yields through quality, moderate-duration exposure instead of loading up on the long end. Scenarios that would reward long duration, a policy-error scare, an energy resolution, a data-centre slowdown, or a short squeeze among commodity trading advisors, are real but asymmetric, better expressed through call options on Treasury futures than outright duration. Gold now makes up roughly 26.3% of global central bank reserves versus 20.2% for Treasuries, the first time it has ranked ahead since the mid-1990s, a credibility hedge worth pairing with bonds.

Bonds are back as an income and relative-value asset; they are not yet back as the portfolio's shock absorber.