Startling headlines about the bond market are inescapable.
Yields of U.S. Treasuries this week touched their highest levels since the financial crisis of 2007, and bonds in Canada, Japan, Germany breached levels they hadn’t reached in at least a decade.
On Wednesday, the U.S. government intervened, briefly stanching the bond market rout. The Treasury Department announced it was increasing its capacity to buy longer-term bonds, to $4 billion per weekly operation, from $2 billion. In response, yields moved a bit lower. This followed another Treasury intervention this month that bolstered the Japanese yen and, briefly, lowered yields on longer-term Treasuries.
But volatility in the bond market returned on Thursday as investors remained on edge.
The possibility of further action by the Treasury — and, perhaps, by the Federal Reserve — makes predicting bond yields and prices exceptionally hazardous at the moment.
Bond market turmoil can be disconcerting for investors, who turn to high-quality bonds, especially Treasuries, for safety. It would be easy to think: If this is safety, count me out.
But bonds continue to have many virtues. High-quality, individual bonds, especially Treasuries — as well as most mutual funds and exchange-traded funds that hold them — have traditionally been far more stable than their stock counterparts. Shares can collapse in price, U.S. Treasuries, in particular, are all but guaranteed to maintain their value, plus interest, when held to maturity. Bonds are always a valuable part of a long-term investor’s tool kit. But you need to be careful when using them.
Undeniably, even solid bonds have lost market value this year. There’s an enduring lesson in that: If you intend to park your cash for a few months or need to sell before a bond hits maturity, you get whatever the market is offering. There are probably better options, like money-market funds, high-yield savings accounts and certificates of deposit. Bond funds are better for the long haul. They can be portfolio stabilizers, offsetting the volatility of stocks.
The central problem for bond investors this year is that price declines are inevitable when interest rates rise. That’s essential bond math: Prices move in the opposite direction of interest rates or yields. Throughout much of the world, interest rates have been soaring.
That’s making bond investing especially tricky right now.
Rising Rates
The bond market sets interest rates through a vast series of moment-by-moment decisions by thousands of traders. As I wrote earlier this month, the market is saying that global risks are rising. A partial list of those risks includes: the possibility of even higher inflation; fiercer wars and tariffs and other geopolitical dislocations; questionable use of immense sums of capital to build artificial intelligence; an uncertain direction for the Federal Reserve under its new leadership; mounting national debt; and broad political dysfunction.
Where rates are going tomorrow is impossible to say. But the much bigger question is how high they will go in the next decade. That’s a reasonable threshold if you’re contemplating the purchase of bond that won’t mature for 10 or even 30 years. Even at their recent peaks, yields aren’t that high — not yet — on a historical basis. The economy in the past has grown resiliently when yields were much higher than they are now.
Capital Economics, an independent financial research firm in London, takes that perspective, saying on Tuesday, “The recent sell-off in global government bond markets is significant, but it does not yet amount to a crisis.” Yes, higher yields have driven up costs for borrowers of all sorts, from people seeking mortgages to those carrying credit card debt and student loans, and for companies with big capital needs, like the tech giants building A.I. data centers with mountains of borrowed money.
But the economy is still growing and the stock market has largely shrugged off higher yields so far, Capital Economics said, adding: “The immediate macroeconomic impact should remain limited unless the rise in yields spreads” or if it leads to a broader “tightening of financial conditions.”
A Central Problem
Most individual investors in the United States hold stocks and bonds through funds, not as individual securities. In calm times, it was reasonable to think of bond funds simply as “Steady Eddies” that you could count on for reliable, if modest, returns.
They provided a buffer against wild swings in stocks, the prima donnas of financial markets, with their enticing rewards and all-too-frequent disappointments.
Lately, however, it’s the bond funds that have been disappointing.
This year, they are down in value nearly across the board, reflecting the sea change in global interest rates.
That’s hurt short-term investors. But there is a bright side for those taking a long view. The key is this: If yields linger on a higher plateau, future bond returns will be richer.
That’s because fund managers constantly need to buy new bonds, and higher-yielding ones will generate more income for investors via higher interest payments. In that respect, prospects for bond fund investors right now are better than they were before rates increased. It’s like “buying the dip” in a stock index after prices have fallen. You’re ahead of the game — assuming the market moves in the right direction.
Don’t get too excited, though. If yields continue to surge higher, instead of plateauing, there will be further losses. In that case, parking your money elsewhere will turn out to be a better course.
This dynamic affects individual bonds, too, though if you hold a Treasury to maturity, you needn’t worry much about shifts in market value. Bond funds, however, are required to “mark to market,” or post the latest market prices, so the pain of losses is right there, out in the open.
What to Look For
Unsuspecting investors may be dismayed by aspects of bonds that look like flaws but are, in fact, essential features.
For instance, interest rate increases tend to have a greater negative impact on longer-dated bonds — more precisely, on those with greater “duration,” a measure of a bond’s response to changing rates. This core property of bonds is why long-term Treasuries, often said to be the safest of securities, have been among the hardest hit this year.
For example, since the U.S. and Israeli attack on Iran drove up interest rates in late February, the iShares 20+ Year Treasury Bond E.T.F. — which holds only long-term bonds — has lost more than 8 percent, in total return. In that same period, the Vanguard Total Bond Market Index fund, which contains corporate bonds, in addition to Treasuries, lost “only” about 2 percent.
The Vanguard fund is simple. It tracks the investment-grade benchmark, the Bloomberg U.S. Aggregate Bond Index. But from the performance standpoint, the gap between the Vanguard and iShares fund mainly comes down to duration: The Vanguard broad bond market fund has a duration of about 5.7 years, compared to 14.9 years for the iShares long-term Treasury fund, according to FactSet.
What those numbers mean is that every time rates shift, price changes are magnified in the long-term Treasury fund. So before buying any fund, you may want to check its duration for a clue about how it will behave when interest rates, which you can’t control, start to oscillate. The higher it is, the greater the fund’s price moves when interest rates shift.
Another worthwhile metric is standard deviation, a statistic that tells you how much a fund’s price swings. The iShares fund has a relatively high standard deviation, and from this perspective, it looks much more like a stock fund, in the wildness of its fluctuations, than a core investment-grade bond fund, like the Vanguard Total Bond Market Index Fund.
The swings of the Vanguard Total Bond Market Index this year, using that measure, have been modest: about one-third that of the overall U.S. stock market, as tracked by the Vanguard Morningstar Total Stock Market ETF, according to FactSet.
These kinds of details point to larger considerations: They suggest that even if bonds, and bond funds, have been hurt by interest rate increases this year, it’s possible to avoid extreme fluctuations by choosing carefully.
What’s more, it’s worth remembering that in big downturns, high-quality bonds provide safety guarantees that you can’t get from stocks.
I happen to prefer the ease and diversification of broad index funds for both stocks and bonds. But high-quality, individual bonds (including municipal bonds, for minimizing tax liabilities) can be worthwhile, too. I’d add a major caveat: Try to make sure that you won’t need to sell such bonds prematurely. One solution for some retirees is a “bond ladder,” containing a series of individual Treasuries that mature regularly — say, on an annual basis — over periods like 20 years. That approach can provide steady, secure income. (Inflation-protected Treasuries, or TIPS, can be useful in bond ladders, too.)
But you will need to accept that, as long as interest rates shift, the market values of all these bonds will swing, too. And, alas, no one knows where the markets are going, either for stocks or bonds.
That’s why it’s wise to spread your risks. Hold stocks in the hope of big returns; bonds, in case the stocks don’t pan out; and cash, to get through wild swings in the bond market of the kind that we’re having this year.
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