Understanding the Rise in Bond Yields: Implications and Opportunities for Investors (2024)

FAQs

What are the implications of rising bond yields? ›

If bond yields rise, existing bonds lose value. The change in bond values only relates to a bond's price on the open market, meaning if the bond is sold before maturity, the seller will obtain a higher or lower price for the bond compared to its face value, depending on current interest rates.

Rising yields can create capital losses in the short term, but can set the stage for higher future returns. When interest rates are rising, you can purchase new bonds at higher yields. Over time the portfolio earns more income than it would have if interest rates had remained lower.

A bond's yield is the return an investor expects to receive each year over its term to maturity. For the investor who has purchased the bond, the bond yield is a summary of the overall return that accounts for the remaining interest payments and principal they will receive, relative to the price of the bond.

Investors typically demand higher yields to justify holding bonds for longer periods. But a steep curve—high yields on longer-maturity bonds relative to shorter maturities—also means you need to watch out for higher inflation rates.

Furthermore, investors' behavior can significantly impact the correlation between the stock and bond markets. Due to investors' risk preferences in different markets, when long-term government bond yields rise, the stock market tends to fall.

When bond yields go up then the cost of capital goes up. That means that future cash flows get discounted at a higher rate. This compresses the valuations of these stocks.

one key risk to a bondholder is that the company may fail to make timely payments of interest or principal. If that happens, the company will default on its bonds. this “default risk” makes the creditworthiness of the company—that is, its ability to pay its debt obligations on time—an important concern to bondholders.

Short-term bond yields are high currently, but with the Federal Reserve poised to cut interest rates investors may want to consider longer-term bonds or bond funds. High-quality bond investments remain attractive.

A bond's yield is the discount rate that links the bond's cash flows to its current dollar price. A bond's coupon rate is the periodic distribution the holder receives. Although a bond's coupon rate is fixed, the price of a bond sold in secondary markets can fluctuate.

Why do bond yields rise with inflation? ›

The timing of a bond's cash flows is important. This includes the bond's term to maturity. If market participants believe that there is higher inflation on the horizon, interest rates and bond yields will rise (and prices will decrease) to compensate for the loss of the purchasing power of future cash flows.

When yields rise, this signals a drop in the demand for Treasuries because investors are bullish about the economy and seek higher returns elsewhere.

Unless you are set on holding your bonds until maturity despite the upcoming availability of more lucrative options, a looming interest rate hike should be a clear sell signal.

Savings Bonds

These are typically considered safe investments because the value can't decline, which makes them a stabilizing investment during inflation or other periods of uncertainty.

After bonds are initially issued, their worth will fluctuate like a stock's would. If you're holding the bond to maturity, the fluctuations won't matter—your interest payments and face value won't change.

These bonds are often called high-yield corporate bonds. Unlike the name “junk bond” suggests, some of these bonds are an excellent option for investors. Just because a bond issuer is currently rated at lower than investment-grade, that doesn't mean the bond will fail.

Bond investors (and any other investor, for that matter) can decrease the volatility in their portfolios during rising-rate environments by moving to or investing in bonds with short-term maturity dates or purchasing bonds with coupon rates that float in concert with the market rate.

A normal yield curve shows bond yields increasing steadily with the length of time until they mature but flattening a little for the longest terms. A steep yield curve doesn't flatten out at the end. This suggests a growing economy and, possibly, higher inflation to come.