What will happen next to bond yields and interest rates? And how should that influence what investors do with their spare cash?
Bond yields began moving higher in earnest early last year in response to a series of interest rate hikes by the Federal Reserve. Earlier this month, the yield on the benchmark 10-year U.S. Treasury note hit its highest level in 16 years, while yields on shorter-term debt securities also rose.
That makes it a very attractive place for investors to park their money. Stocks have taken a hit as investors adjust their portfolios to take advantage of more attractive bond yields.
Yields climbed again Friday morning after the stronger than expected September jobs report. The yield on the two-year Treasury note
rose to almost 5.1%, up from 5.023% Thursday afternoon and up from 4.26% a year ago.
“‘Bond yields rose primarily because the Fed pivoted to a much more hawkish position, as investors anticipated aggressive interest rate hikes to rein in inflation.’”
The yield on the ten-year Treasury note
climbed to 4.86%, up from 4.715% Thursday afternoon, and up from 3.82% a year ago. The yield on the 30-year bond
reached 5.01%, up from 4.88% on Thursday and up from 3.78% a year ago – heading Friday morning for the highest level since August 2007.
But will rising yields influence the Federal Reserve decision making on interest rates? Some analysts say yes.
Steen Jakobsen, Saxo Bank’s chief investment officer, said officials will began mulling rate cuts in 2024, while the spike at the long end of the yield curve will eventually nudge the Fed to take action “first through flagging a needed policy shift that keeps the ten to thirty-year yields capped at perhaps 500-525 basis points (5.0%),” he wrote in a note.
“Bond yields rose primarily because the Fed pivoted to a much more hawkish position, as investors anticipated aggressive interest rate hikes to rein in inflation,” Bill Merz, head of capital markets research at U.S. Bank Wealth Management, said this week.
On Thursday, Mary Daly, president of the San Francisco Fed, told the Economic Club of New York that the jobs market and consumer prices are two factors in the Fed’s thinking. “If we continue to see a cooling labor market and inflation heading back to our target, we can hold interest rates steady and let the effects of policy continue to work,” she said.
“‘If you need the cash for a down payment on a house in the next 18 months then placing it in a 2- or 3-year Treasury probably won’t work.’”
Usually when someone buys bonds, the interest comes in the form of a fixed, recurring “coupon” payment. Treasurys, for example, pay interest every six months until maturity. (Treasury interest income is taxed at the federal level, but exempt from state and local tax. Other interest income, like the yields on CDs, have no special tax treatment.)
In the buy-and-hold approach, “knowing when you might need access to this money is key to deciding where to put it,” said Greg Vojtanek, owner Fade In Financial, a Los Angeles-based financial planning firm. “If you need the cash for a down payment on a house in the next 18 months then placing it in a 2- or 3-year Treasury probably won’t work.”
“On the other hand, if you don’t need this money for another 20-years and you’d like a small portion of your portfolio to be safely placed in cash, then buying longer-term Treasurys is a perfectly fine option,” he said.
“Retirees drawing down their money may be in ‘statement shock’ now, amid the lower prices in the bond market where they’ve built up exposure.”
When investors buy and sell ahead of maturity the inverse relationship between prices and yield comes into play. Currently, Wall Street traders are guessing when the Fed stops raising its federal funds rate — and when it will start cutting the rate.
Treasury bills, which come due within a year, have been a yield-producing place to put cash. Yields on T-bills
of varying length are over 5%, up from roughly 4.5% around the start of the year.
As a result, high-yield savings accounts, certificates of deposit and money market-mutual funds have all become alluring ways to reap rewards for parking cash. It’s easy to find these products with rates in the 4% and 5% range.
Fed weighs its options
Suppose the Fed decides it’s done tightening and later cuts the rate. Now suppose there’s someone who bought longer-term Treasurys at today’s higher yields and then decided to sell at a time of falling interest rates.
“When that happens, the price of bonds will increase, and the investor will have the benefit of a high-yielding bond based on the purchase price and a bond that increases in price. That’s great because it gives the investor more flexibility,” said Chris Chen, CEO and a wealth strategist at Insight Financial Strategists in Newton, Mass.
The central bank is “either at or close to the peak” in its interest-rate tightening plan, said David Sekera, chief U.S. market strategist at Morningstar, the investment research firm. Rate cuts could start as early as March of next year, according to Morningstar projections.
Of course, that’s just one projection — and determining the direction of interest rates and timing is tricky.
Now suppose the Fed isn’t done with interest rates. The benchmark rate is at a two-decade high with its 5.25% to 5.50% target range, and Fed Chair Jerome Powell recently reiterated that the central bank will follow the economic data to determine its next move.
If interest rates keep increasing, the purchase of high-yielding, long-dated Treasurys doesn’t seem so enticing.
“If interest rates keep increasing, the purchase of high-yielding, long-term Treasurys does not seem so enticing.”
“The prices of long-dated bonds move much more dramatically than the prices of shorter-dated bonds,” said Mike Silane, managing partner of 21 West Wealth Management in Irvine, Calif. “First-time investors in long bonds may be shocked by how much money they could lose in a short period of time, should rates continue to rise, as some have forecasted.”
Retirees drawing down their money may be in “statement shock” now, amid the lower prices in the bond market where they’ve built up exposure, said Matt Sommer, head of specialist consulting group at Janus Henderson Investors.
Sommer said he’s advising older clients to leave their bonds alone and tap their stock gains if they need cash flow. That will give bond portfolios time to recover their value on paper, he said.
Treasurys held to maturity will return all the principal, Sommer said. The dips shown on statements are a “paper loss” based on current market valuations, not real losses.
“That’s why we can’t emphasize enough, even though you are experiencing statement shock when you are looking at your Treasurys on your screen or on your statement,” Sommer said, “now is not the time to sell.”
Quentin Fottrell contributed.