The bond headlines just won’t go away, and for good reason.
Interest rates are rising all over the world. In the United States, yields on Treasury bonds are hovering around levels that haven’t been reached in decades, setting off alarms about the state of the economy and causing hardship for millions of people.
Just about everybody is affected by rising rates — in their roles as investors, consumers, taxpayers and more.
Yet for a force that important, bonds remain remarkably opaque. Unless you are already familiar with them, you may not know what people are talking about when they talk about bonds.
Stocks are easier to talk about. When someone says the stock market fell, you know roughly what happened: The average stock price of a brand-name index, like the S&P 500 or the Dow Jones industrial average, declined.
But when the bond market is “down,” who, aside from bond mavens, understands that it’s because yields are “up?”
So here’s an attempt at clearing up a few basics, starting with some of the central causes of the bond market turmoil. In a nutshell, they include uncomfortably high inflation linked to wars, spiking oil prices, punitive tariffs, enormous government deficits causing a glut in the supply of bonds, rapid economic growth and a sense of rising risk around the world.
The recent market mayhem may be a sign of economic trouble. But it also presents an opportunity for long-term investors who understand what’s going on because high yields now predict better bond returns in the future.
Why Up Means Down
Yields and prices move in opposite directions. Market analysts, academics and journalists constantly repeat this fact. It’s part of basic bond math — and it’s why bonds fall when interest rates rise.
But what’s this relationship between interest rates (or yields) and prices all about?
Start with a straightforward method for determining bond market interest rates: an official auction run by a government department, like the Treasury.
When the Treasury needed to sell 10-year notes at an auction on Aug. 12, it couldn’t control those rates directly. It had to reach a deal with the bond market. In a climate of rising risk, traders demanded more interest for lending money to the government, pushing the rate of 10-year Treasuries to heights not seen since 2007 — 4.63 percent, an unexpectedly elevated level that commanded global headlines.
Since that August auction, and despite repeated attempts by Treasury Secretary Scott Bessent to drive down rates, traders have bid prevailing interest rates higher. On Thursday, those rates exceeded 4.9 percent for 10-year Treasuries, according to FactSet — far more than the rate set in that auction one month earlier.
What has happened is that market pressures have affected interest rates. Now, consider how those pressures affect the yields and prices of individual bonds.
While interest rates rose sharply in the overall bond market over the month since the auction sale of the 10-year Treasury, the original promise of the government to repay the Treasury note in full, at a 4.63 percent “coupon” rate — didn’t change at all. So something else had to give, and it was the price at which those notes were sold.
The market had moved on and traders were no longer willing to pay the same price for a Treasury with that old interest rate. The yield — which Vanguard defines as what investors receive in income for holding a bond, expressed as a percentage of its market price — rose, as the price adjusted downward.
That’s why the market is down when yields are up.
Why Are Rates Rising?
This simple question has many answers.
Inflation is the simplest. It has been too high for years, so standard economics suggests that the Federal Reserve and other central banks are likely to raise short-term interest rates to combat it. Those shorter-term rates usually connect with the longer-term rates that are the bond market’s domain.
If, for example, the bond market suddenly became convinced that the Federal Reserve would be raising interest rates over the next two years, the current two-year Treasury note would rise accordingly, and so on, simply on a mechanical basis. In addition, in periods of high inflation, bond investors demand greater compensation in the form of higher “nominal” yields to receive adequate real, or inflation-adjusted, returns.
There are undoubtedly other factors. By bidding yields higher, the bond market is saying that global risks are rising, and investors need to be paid for bearing these risks.
The Fed, which finds itself in a difficult position, is a major factor.
The Fed’s main domain is short-term rates, starting with overnight loans. When policymakers next meet, on Tuesday and Wednesday, they will announce a target for a key rate in the market — the federal funds rate, which is the central bank’s policy rate. The current rate 3.50 to 3.75 percent. Financial markets believe that because inflation is uncomfortably high, this rate is far more likely to rise than to fall.
That’s the case, despite President Trump’s insistence that the Fed must slash rates, putting the Fed’s new chairman, Kevin M. Warsh, in a bind. Mr. Warsh says he wants to tamp down inflation, which implies raising rates, but he presumably doesn’t want to antagonize Mr. Trump, who appointed him to the job. This apparent conflict involving a rudimentary responsibility of the Fed is also affecting the bond market, where longer-term rates are reached through thousands of deals between individual traders.
If traders believe that the Fed won’t act when it should and that inflation is likely to keep rising, they will tend to bid up bond yields. That may be happening now.
In addition to inflation and an uncertain direction for the Fed, other dangers include the possibility of fiercer wars and tariffs and other geopolitical dislocations; questionable use of immense sums of capital to build artificial intelligence; rising government deficits that are flooding the market with bonds; and broad political dysfunction.
It’s also true that while bond yields have been rising from the sub-1 percent level to which they fell during the nadir of the Covid pandemic in 2020, they are not very high on a historical basis. Jim Reid, an analyst at Deutsche Bank, estimated that the average yield of 10-year Treasuries since 1800 was 4.5 percent.
As a result, he wrote, the bank “would see the recent rise in yields as the continuation of a long normalization process.” He added that at current levels, yields “certainly are not extreme.”
Is This Good, or Bad, for Investors?
Rising rates are hurting ordinary people and weighing on the economy. They have driven up the costs of mortgages, credit card debt and student loans, and of big capital projects, like A.I. data centers built on mountains of borrowed money.
But for investors, the financial effects are less clear. The stock market has stalled lately but hasn’t really been affected much by higher borrowing costs, probably because corporate profits, fueled by capital expenditures on A.I., have been extraordinarily high. But if rates keep rising, watch out.
As for bond investors, it depends on whether you’re looking backward or forward. There’s no doubt that if you’ve been holding diversified bond investments this year, your holdings have declined in value. That may not matter to you if you intend to hold a bond to maturity. In that case, if it’s a high-quality bond, you are likely to collect exactly what you expected in interest and recover all of your principal. That’s precisely what bonds are designed to do, and they are still doing it.
But if you own your bonds in a mutual fund or exchange-traded fund, or need to sell an individual bond, falling prices have outweighed rising rates, and you have lost some money.
Here are two examples, with returns this year through Thursday, according to FactSet:
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The iShares 20+ Year Treasury Bond E.T.F. — which holds only long-term bonds — lost 4.5 percent, in total return.
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The Vanguard Total Bond Market Index fund, which contains corporate bonds in addition to Treasuries, lost 0.6 percent.
As I pointed out recently, bonds with long maturities, or “duration,” tend to respond more strongly to interest rate shifts than shorter-term bonds, and the iShares fund suffered because of its long-term holdings.
That said, higher interest rates now suggest that future bond returns will be higher, too. The richer yields will buffer price losses that inevitably occur when market interest rates rise.
Back in 2023, yields were around where they are now. I suggested on Oct. 13 of that year that despite recent losses, it was a good time to buy bonds. That has turned out to be correct — even after the recent bond market rout — because rich yields, combined with moderately rising bond prices, generated solid returns.
Here are the returns for the same two funds, from Oct. 13, 2023:
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The iShares 20+ Year Treasury Bond E.T.F. gained 4.3 percent, in total return.
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The Vanguard Total Bond Market Index fund gained 15.4 percent.
Much as in 2023, I believe that, while there’s a chance that yields will surge a great deal more, this is a reasonably good time to buy bonds. Still, unless the stock market crashes, bonds aren’t likely to outperform stocks. The S&P 500 gained 83.3 percent in the same period, and in big stock market rallies like this one, bonds can’t keep up.
But rallies don’t last forever, in either market, and when bonds fall in value, they don’t fall nearly as far as stocks do. What’s more, now that yields are higher, the income that bonds are generating will more fully buffer investors against further rate increases (and price declines). All of the recent headlines may mask that fact.
Bonds may not be the Steady Eddies that they appear to be in periods of low inflation, but high-quality bonds are still worthwhile for preserving your money while providing a decent return. I try to keep enough cash around for emergencies, and always hold both stocks and bonds.
Don’t let the bond market headlines scare you too much. The bond market’s troubles are opening opportunities for patient investors.
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