The bear market in stocks has made portfolio values drop sharply so far in 2022. But for many investors, the bigger surprise this year has come from the terrible performance of the bond market, which has seen its worst losses in decades. Many had turned to bonds as a more conservative investment than stocks, and so the steep declines even in what are considered to be ultra-safe Treasury bonds have been especially painful.
Inflation has prompted the Federal Reserve to boost short-term interest rates aggressively, and that has had an impact on many longer-term bonds as well. On Wednesday morning, the yield on the 10-year Treasury briefly moved above 4% for the first time since 2008. That has significant implications for both stocks and bonds that investors need to consider in making investment decisions.
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The big rise in Treasury rates
The most difficult aspect of what's happened in the bond market is that the rise in rates has come so fast. Near the beginning of the COVID-19 pandemic in early 2020, the Fed sharply cut interest rates, sending 10-year Treasury yields down to around 0.5%. Even as the economy started to rebound, yields remained below 2% for a prolonged period of time. Just a year ago, the yield was at 1.5%.
^TNX data by YCharts. NOTE WELL: Index values represent the yield in percentage points multiplied by 10.
It was only once inflation reared up in early 2022 that bond investors started to lose their nerve, and the brief move above 4% represented yields that were 2.5 times where they started the year.
Rising yields mean falling prices for bonds, and the damage has been severe. Even ordinary bond index ETFs have seen massive losses, with the popular iShares Core U.S. Aggregate Bond (AGG 0.10%) and Vanguard Total Bond Market (BND 0.13%) both down 15% year to date. Bond funds with a bias toward longer-maturity bonds have seen even bigger declines, with iShares 20+ Year Treasury (TLT 0.36%) down nearly 30%. Even bonds that were supposed to protect against inflationary pressures have seen price declines, with iShares TIPS Bond (TIP 0.15%) down 18% from where it started 2022.
What consumers and investors should expect
Already, the impact of higher Treasury yields is working its way through the broader economy. Mortgage rates tend to correlate with 10-year yields, so rates on 30-year mortgages have also hit new highs above 6.5% recently. That is making homes less affordable for would-be homebuyers, as monthly payments on new mortgages for a given amount of debt are far higher than they were earlier this year.
Nor can stock investors entirely ignore the impact of yield increases. Many companies raised their debt levels when interest rates were lower, taking advantage of cheap financing to bolster their growth efforts. Those companies that can pay back that debt as it matures should be in good shape, but those that had hoped to refinance their debt to delay having to pay it back face the prospect of sharply higher interest payments in the future. Given that the companies most likely to want to refinance are also often the ones that are least able to afford higher financing costs, investors need to watch closely to ensure that the companies whose stocks they own aren't facing potential problems.
Higher rates do have a silver lining, though. For those with cash who want to lock in a certain return, buying individual Treasury bonds now will give them interest payments at a level they haven't been able to get in years. Admittedly, 4% isn't enough to make a wholesale shift out of stocks. But for those who have found that the stock market volatility of the past year has made them uncomfortable with their asset allocation strategy, higher yields make now a better opportunity to invest in bonds than investors have seen in a long time.
