Bond yields are surging, tantalizing investors with an income stream that might look attractive. But if you’re a tad nervous about making a big move, you’re not alone.
Today’s action looks worse than the inflation scare of 2022. Back then, bond yields – which move in the opposite direction to bond prices – rose dramatically in anticipation of aggressive interest-rate hikes by central banks.
But this week, yields surpassed those levels. The yield on the 10-year U.S. Treasury bond blew through 5.1 per cent on Wednesday, surpassing its 2023 high point. Early Friday, it topped 5.2 per cent.
The yield, which affects borrowing costs and can influence bonds in other countries, including Canada, is now at its highest level since 2007.
The more significant difference today: The underlying causes of rising bond yields may be more worrisome.
Three years ago, we were dealing with the lingering effects of supply chain disruptions and the extraordinary stimulus required to keep the global economy ticking during pandemic lockdowns.
Now, we may be facing bigger problems.
Though war and rising energy prices are driving inflationary pressures, some challenges are more intractable. In particular, bond yields may be responding to massive government deficits and debt levels, where few observers see any near-term solution.
In the United States, total publicly held debt crossed the US$40-trillion threshold last month, representing 100 per cent of the country’s gross domestic product.
The debt-to-GDP ratio is set to keep climbing without extraordinary economic growth or severe tinkering to government deficits that have been running at about 6 per cent of GDP.
As well, some corporations – particularly hyperscalers – are issuing massive amounts of long-term debt that is effectively competing with government bonds. This could be contributing to rising yields.
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The bull market for bonds, which persisted since the 1980s as inflation declined with global trade and aging demographics, may be over.
“This isn’t a structural bull market any more. The playbook that worked over the past few decades, we need to reassess,” said Bipan Rai, head of ETF and alternatives strategy at Bank of Montreal.
Given that financial markets are expecting central banks to increase their key rates into next year, Mr. Rai isn’t enticed by today’s higher bond yields.
There appears to be little interest among smaller investors, too.
Daniel Straus, managing director of ETFs and financial products research at National Bank of Canada, said that the flow of money into exchange-traded funds still heavily favours equities.
“It seems like everyone and their cousin very much wants to participate in the latest round of tech growth,” Mr. Straus said.
And bonds? “The appetite for fixed income doesn’t seem to be taking root,” he said.
This trend away from bonds might not sit well with investors who preside over diversified portfolios. If you hold stocks and bonds in defined proportions – in the case of a balanced portfolio, that’s typically 60/40 in favour of stocks – you could be in a quandary now.
That’s because stocks have surged over the past 18 months, while bond prices have withered. Investors with stock-heavy portfolios would likely be pushed toward adding bonds if they want to rebalance.
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Another reason some investors might be considering bonds: They can provide stability during stock-market downturns and economic recessions. Anyone nervous about either event could see today’s rising bond yields as a potential gift.
Still, you can side with the skeptics without avoiding bonds altogether.
Consider safe money-market funds. Or for a little more risk, consider ETFs – the easiest way for small investors to buy bonds – that focus on short-term bonds. With maturity dates not far off, these bonds are less sensitive to rising interest rates.
The Vanguard Short-Term Treasury ETF is down just 1.1 per cent over the past three months, not including distributions. The Vanguard Long-Term Treasury ETF, on the other hand, has suffered a far more severe 8.3-per-cent decline, as of Thursday.
Another approach: Consider corporate bonds, which are one step removed from the nagging issue of government deficits.
The BMO Short Corporate Bond Index ETF invests in investment-grade corporate bonds issued in Canada, with maturity dates one to five years away. The unit price is down 1.8 per cent over the past three months.
Bonds are clearly suffering this year, and the case for loading up on them could be many months away. The good news? You don’t have to sit idle.