Even when U.S. economic data matches levels last seen in 2007, it often doesn’t feel like good news. But the 10-year Treasury note, which offers the highest yield since that year, could be good news for investors looking to buy bonds.
Rising inflation, particularly oil prices, combined with expectations that the Federal Reserve will raise interest rates at least once more this year, pushed the 10-year Treasury yield to 5.208% on Thursday, its highest level since June 2007, before the global financial crisis. Yields continued to rise on Friday.
Rising long-term bond yields are often seen as a headwind for stock markets because they correlate with higher borrowing costs for consumers and businesses, which can slow the overall economy. This could be particularly bad news for consumers looking to take out mortgages or other loans.
“As the 10-year Treasury yield rises, the cost of borrowing a mortgage will rise almost in tandem,” said Dominic J. Pappalardo, chief multi-asset strategist at Morningstar Wealth. “Even things like auto loans are affected. In fact, all consumer credit and borrowing rates are pretty closely tied to the 10-year Treasury yield.”
On the other hand, rising U.S. Treasury yields present an opportunity for bond investors.
“Rising interest rates benefit savers and investors as much as they hurt spenders,” Pappalardo said. “If interest rates rise but you still have money available to save or invest, you will either pay a higher interest rate or earn more from your savings or investments because the yield will rise.”
The “real yield” on Treasury securities, which measures yield after adjusting for expected inflation, has risen on a net basis since February, when the war with Iran began and oil prices soared. Investors can particularly benefit from higher yields on long-term bonds, as they may be able to lock in higher interest rates for longer periods of time. Yields on long-term government bonds are determined by the bond market and generally respond to factors such as rising inflation expectations.
“So there’s potentially a very strong opportunity to lock in at very attractive levels,” said Steve Raipley, global co-head of BlackRock’s iShares fixed income ETF. “We call this an intergenerational income opportunity.”
Financial and investment experts warn against making large capital moves based on short-term market conditions. Buying bonds just because they look good at the moment may not be the best move for all investors. We recommend consulting with a professional to see what makes sense for your financial situation.
Who should consider buying bonds right now?
When inflation expectations are high, bond yields tend to rise. Rising oil prices due to the war with Iran have contributed to rising bond yields since February, and recent comments from the Fed have led investors to expect continued inflation and further interest rate hikes.
Treasury bills and government bonds typically make fixed interest payments. As yields rise, the prices of existing government bonds tend to fall. This is because the fixed payments are lower compared to newly issued government bonds, making them less attractive to investors. The opposite happens when yields fall.
Investors typically hold bonds to diversify their portfolios with assets that allow them to keep more of their money in a less volatile vehicle than stocks. Treasury bills and bonds also offer an income benefit, as they pay interest every six months.
Mr. Pappalardo said that while individuals nearing or already retired may benefit most from rising U.S. Treasury yields, investors with short-term to immediate goals, such as those looking to buy a home within the next five to 10 years, may consider adding to or increasing their bond holdings.
Additionally, “investors need to know their time horizon,” says Raipuri. “Do they want to invest for five years, or are they comfortable investing for the long term, or do they just want to stay nimble?”
This week’s acceleration in bond yields may be appealing to investors, but they could continue to rise. Ripley said U.S. Treasury yields could rise further if the Fed raises rates more than already priced in, or if oil prices rise significantly.
On the other hand, bond yields could fall if the conflict with Iran escalates and oil prices calm down soon. Ultimately, investors shouldn’t try to time the bond market. But Pappalardo says U.S. Treasury yields are less risky than trying to time the stock market.
“Even if interest rates go from 5% to 6%, you may certainly see some price declines, but they will be relatively small,” he said. However, the impact may vary depending on the bond’s duration, which is a measure of a bond’s sensitivity to changes in interest rates.
Investors can buy individual bonds to suit their time horizon or use fixed income exchange-traded funds to gain broader exposure, Leipley said.
“Say you have an investor who is very cautious and wants to wait a little bit until things calm down before deciding to invest and commit further outside the curve. They might buy something like SGOV,” he says. This ETF includes Treasury bills with maturities of three months or less.
“There are many ways for investors to earn income without feeling like they’re taking on unpleasant risks,” he says.
However, as with the stock market, Pappalardo advises investors not to make emotional investment decisions. While it may be exciting to see the income potential with Treasury yields at high levels for decades, “I wouldn’t recommend that anyone completely restructure their entire portfolio or investment approach today,” he says.
“It is prudent and logical to adjust to try to take advantage of new marginal opportunities to generate more income from fixed income investments,” he added. But “instead of blowing everything up, start from scratch.”
For example, if 10% of your portfolio is currently invested in bonds, you might consider increasing that allocation to 15% or 20%, he says, depending on your time horizon and risk tolerance.
