What’s Going On With the Bond Market?

If you have read the financial news lately, you may have seen some alarming headlines about a “bond market selloff”…which certainly sounds scary!  But, with all gripping headlines, there is a lot going on under the surface which creates more a more nuanced situation!

Quick refresher lesson on bonds…as we’ve written about in the past (here and here)…when bond prices fall, their interest rates—or yields—go up. Think of it like a seesaw:

Bond prices down = bond yields up.

Recently, investors have been selling government bonds, pushing their prices down and their yields up. In August, the yield on the 30-year U.S. Treasury reached its highest level since 2007. (CNBC)

Why are investors selling bonds?

There isn’t one simple answer. Several things are happening at once.

1. Inflation worries are back

Inflation is probably the biggest concern right now.

The war in the Middle East has pushed oil prices sharply higher. Higher oil prices do not just mean paying more at the gas pump. Energy is used to make and move almost everything we buy. That means higher energy costs can eventually show up in food, travel, shipping, manufacturing, and many other prices.

That has investors worried that inflation may remain higher than expected. And if inflation stays high, the Federal Reserve may need to keep interest rates higher—or even raise them, which directly impacts all bonds.

If investors think interest rates will be higher in the future, they are less willing to own an older bond paying a lower rate today. So the price of that older bond falls.

This concern isn’t limited to the United States. Bond yields have recently risen around the world as oil prices and inflation worries have increased. (The Guardian)

2. The government needs to borrow a lot of money

There is also a simple issue of supply and demand.

The U.S. government spends more money than it collects in taxes. To make up the difference, it borrows money by selling Treasury bonds.  So, there are a lot of Treasury bonds that need buyers!

When there is more of something for sale, buyers can become more selective. Investors may say, in effect: I’ll lend you my money, but I want to be paid more for doing it.  So…higher yields typically follow.

3. The economy is still pretty strong

This one may seem strange–some of the rise in bond yields may actually reflect good economic news.

A research article written by Fidelity points out that the labor market remains healthy, consumers continue to spend, corporate profits have been strong, and businesses continue to invest heavily in artificial intelligence and other projects. Fidelity describes the economy as still being in a “mid-cycle expansion,” rather than approaching a recession.

It sounds counter intuitive that a strong economic backdrop would hurt bonds, but in reality, it does have an impact.

A strong economy can keep inflation higher. It also means the Federal Reserve has less reason to rush to lower interest rates. So the market is adjusting to the possibility that interest rates may simply stay higher for longer.

4. There is a lot of competition for money

Governments aren’t the only ones borrowing.

Companies are spending enormous amounts of money building data centers, power plants, technology infrastructure, and other projects tied to artificial intelligence. Much of that investment also needs to be financed…which means that governments and companies are competing for the same pool of money from investors.

Think about it this way: If lots of people want to borrow your money at the same time, you can demand a better interest rate before agreeing to lend it.

5. Investors want to be paid more for uncertainty

Finally, there is simply more uncertainty.

Investors do not know exactly where inflation is headed. They don’t know how long energy prices will remain high. They don’t know what the Federal Reserve will do next. And they don’t know how government borrowing will change in the years ahead.

That matters even more when buying a 20- or 30-year bond.

If you are going to lend someone money for 30 years, you want to feel pretty confident about what that money will be worth when you eventually get it back.

Today, investors are asking to be paid a little more for taking that risk.

Is this bad for bond investors?

In the short run, rising yields can hurt the price of bonds you already own. That’s the uncomfortable part—and the part that makes the headlines.

But there is another side to the story:

Higher yields mean bonds now pay investors more income.  For years after the financial crisis, investors complained that bonds paid almost nothing. That is no longer true.

So falling bond prices can actually create better opportunities for long-term investors. New bonds are being issued at higher rates, and the additional income can help offset future price changes.

So, should we be worried?

We are certainly paying attention.

Higher interest rates affect more than bonds. They can mean higher mortgage rates, higher borrowing costs for businesses, and more competition between bonds and stocks. That last point is one of the more important risks to watch in our opinion.  If investors decide that a 5%+ return from a high-quality bond is more attractive compared with taking more risk in the stock market, it could create an incentive to sell stocks one any sign of weakness and create additional volatility over the fall.

But…none of this means investors should panic…yet! 😊

Some of what is happening reflects an economy that has been stronger than expected, combined with a world that may simply have higher interest rates than we became accustomed to over the last decade.

Markets adjust to new information. Sometimes those adjustments are uncomfortable.

Our job is not to guess exactly where bond yields will be next month. It is to make sure portfolios have the right mix of stocks, bonds, cash, and other investments for each client’s long-term plan.

We have written before that markets rarely move in straight lines and that a balanced, diversified approach remains important during uncertain periods. We have also seen how reacting to scary headlines can hurt investors more than the market itself.

The bottom line? The bond market is adjusting to higher inflation, heavy government borrowing, a stronger-than-expected economy, and uncertainty about where interest rates go next. That adjustment can be bumpy, but higher rates also mean bonds are paying investors more—creating opportunities for patient, long-term investors.