Tattered bond market may be approaching ‘escape velocity’ for investors

and 10 years treasury While the market is spooked as yields topped 5% on Tuesday, hitting their highest level since 2007, bond investors are thinking more seriously about whether this is an opportunity for the bond market.

Many investors have recently turned to short-term or very short-term bonds to avoid volatility in the bond market, where prices have plummeted as interest rates rise due to concerns about broader economic issues such as inflation and the federal deficit. But as yields rise, the risk-reward calculation for intermediate-term bonds (bonds with a life of around five to 10 years) becomes more favorable to investors.

Market watchers widely expect the Federal Reserve to raise its target federal funds rate by a quarter of a point on Wednesday amid rising oil prices and the ongoing war with Iran. The move could raise borrowing costs for already struggling consumers. But there are some bright spots for bond investors, especially as interest rates are expected to rise for an extended period of time.

“There’s a lot more cushion than in 2020 because of the rise in yields,” said Alec Lucas, director of fixed income manager research at Morningstar.

Indeed, as more risk-averse investors buy money market funds with attractive yields and don’t have to worry about duration, there are always opportunity costs involved in income-seeking investment decisions, and some investors still prefer stocks that produce attractive yields. But at 5%, investing $1 million in 10-year Treasuries could yield $50,000 a year in yield income alone, or $500,000 over 10 years, making it an attractive investment for wealthy investors looking for a low-risk income stream.

Nevertheless, concerns about bond prices remain elevated and are likely to remain high, and investors may seek opportunistic yield zones within the bond market while recognizing that rising interest rates are not over. “If investors want to ensure that their funds are less likely to react negatively to further increases in interest rates, they may want to prioritize short-to-medium duration portfolios,” Lucas said.

Many bond strategists believe high yields will continue for a long time.

“The rise in bond yields so far this year has been orderly and did not happen overnight, but these increases could continue for some time, especially as geopolitical concerns and high energy prices remain front and center,” Carol Schleif, chief market strategist at BMO Wealth Management, said in a recent commentary.

Respondents to the CNBC Fed survey expect the central bank to raise interest rates at least twice this year.

Here are some basic factors investors looking at fixed income opportunities should consider now.

How bond “price cushions” work and why they are important

Bond prices have an inverse relationship with yields; as yields rise, prices fall. However, in an environment of rising interest rates, investors have a greater cushion if prices fall, and the potential for loss is much lower. This is a function of the significant rise in interest rates from the zero interest rate bottom in 2020 during the coronavirus era.

“If interest rates rise more than 1% in a year, you’re going to be at the mercy of price movements,” said Karen Roche, founder of San Diego-based Discipline Funds. Probably not, because you have a much better starting point,” he said, coining the term “escape velocity” to describe when and how bonds can deliver positive returns even as interest rates rise.

Roche has developed a tool that identifies the point on the Treasury yield curve where the Treasury yield equals the modified duration. At this point, one year’s interest income will offset the price drop due to a 1% interest rate increase. Bonds are free from interest rate risk for the same period of time that they earn coupons. With current interest rates, “if it’s five years or less, you have a cushion, but if it’s higher, that cushion becomes less and less,” he said.

For example, a buy-and-hold investor who owns a bond with a current yield of 4.90% and a duration of 5.8 years can tolerate a 0.84% ​​rise in yield before the mark-to-market loss on the bond wipes out a year’s worth of interest income, said Michael Reynolds, vice president of investment strategy at Philadelphia-based Glenmede. “We’re even more excited about long duration now, because the cost of failure will ultimately become lower as interest rates rise,” he said.

These concepts are important for investors who calculate total return, which is a measure of an investment’s performance over a specified period of time, taking into account price fluctuations and interest. The more interest you can earn, the more cushion you have against falling prices, said Dave Preka, global head of fixed income at Austin, Texas-based Dimensional Fund Advisors.

If you are particularly sensitive to price risk, hold short-duration bonds. Preca said a three-year term, for example, would reduce the risk of price declines. “It’s easy to address risk tolerance” by adding shorter-dated bonds, he said.

Consider extending the maturity period of the bond slightly.

Those who can tolerate a little more risk may find the period a little longer. This means investors may start considering bonds with slightly longer maturities, such as five to 10 years. Reynolds said the “best value for money” appears to be over a seven- to 10-year period. “The further we go, the more volatility there is,” he said.

Scott Helfstein, head of investment strategy at New York-based GlobalX ETF, suggests laddering up to five- to 10-year government bonds. He said interest remains high in one- to three-month bonds, where investors can earn 3.5% to 4% without taking on additional risk. But when you graph the data, “there’s a pretty compelling case” for investing a little longer, he said, adding that investors are getting the highest yields the market has seen in 20 years. Even though he might get a little more in the next year or two, “I’m getting paid better than I’ve been in 20 years.”

Very short-term bond funds, led by the iShares 0-3 Month Treasury ETF (SGOV), remain the most popular strategy for investors in 2026, with SGOV receiving $41 billion in net inflows.

Several ETF options provide investors with exposure to the bond market. iShares 1-3 years (shy) and 3 to 7 years old (IEI) Treasury ETFs fall within these maturity schedules. For broader bond market exposure, consider the Vanguard Total Bond Market ETF (BND) is an intermediate-term bond fund with over 11,000 bonds and an average coupon of 3.9%. The expense ratio as of April was 0.03%. Another option is the iShares Core U.S. Aggregate Bond ETF (AGG), has over 13,000 holdings and an expense ratio of 0.03%. All of these broad-based bond market funds hold nearly half their portfolios in government bonds.

Stocks still have an advantage, but taking profits may be wise

Stephanie Link, chief investment strategist and head of investment solutions at Chicago-based Hightower Advisors, said she still prefers stocks over bonds because of their growth potential, but bonds are becoming more attractive. He said the 5% threshold for 10-year Treasuries makes the bond even more attractive, and if it holds for three to six months, more investors will take notice. Investors whose asset allocation is likely to be biased toward stocks for investment returns may consider taking some of their proceeds and investing them in bonds, he said.

If the risk-free yield is 5% and you’re willing to hold a bond until maturity, assuming inflation doesn’t run away, why not just sell the stock to get 5% and call it a day?That’s unlikely, he said. That’s especially persuasive, he said, if you think inflation will stay at 2% to 3% over 10 years.