Bond yields are on the rise again.
This situation worries many people.
At work John Arnold’s to take:
The 30-year Treasury yield is at its highest level since before the Great Financial Crisis of 2007. Japan’s long-term bond yields have not been this high in an entire century.
Why does this worry people?
Government debt levels are much higher, so higher yields will only increase the amount of the budget going to interest expenses. Some think people are losing faith and trust in the government’s ability to rein in spending. Others worry that this is a sign that inflation is heading to a much higher level.
Some of these concerns are valid. But it’s not all doom and gloom. There are pros and cons when it comes to higher bond yields. More nuance is needed here than a five-alarm fire.
The first thing to consider is that we are finally returning to a more normalized yield environment. For about 3 years yield curve invertedThis means short-term rates are higher than long-term rates. This is not a normal situation. It is worth noting that many experts were predicting a recession that never came because the yield curve was inverted.
Now look at this:
Long-term bond yields must be higher than short-term bond yields to compensate investors for their risk. Nature is healing.
The bond market may also be signaling that we are in an environment of higher economic growth and inflation. Warren Pies Here’s a chart that relates nominal economic growth to sales growth in the S&P 500:
Higher sales growth means higher economic growth. When growth is high, interest rates tend to be high.
The 30-year Treasury bond rate has averaged 6.2% over the last 50 years:
In this context, 5 percent doesn’t seem that high.
Inflation was much lower throughout much of the 2010s. We may be entering an environment where we move from 2 percent inflation to 3 percent inflation:
Inflation poses a major risk for bond investors who receive nominal returns. The bond market may be reflecting expectations of a higher inflation environment.
One place where there is no need to worry about rising interest rates is the stock market.
S&P 500 not worried about higher bond yields yet:
The Japanese stock market is not worried either:
It continues to reach all-time highs, along with 30-year bond yields.
Maybe the stock market actually likes the potential for higher economic growth?
The stock market tends to do well when interest rates rise quickly, but there is also a history of corrections during these periods. Here’s a look at each rising rate cycle on the 10-year treasury and the corresponding total returns and maximum drawdown for the S&P 500:
Rising rates can cause some volatility in the stock market, but if you can hang on, the long-term results are pretty good.
It’s also true that rising rates are a double-edged sword for fixed income investors. Bond prices and rates are inversely related, meaning higher rates lead to lower prices.
But these new higher rates also mean higher expected returns going forward. You replace short-term pain with long-term gain.
Check out: Annex A chart of the week:
A bond’s initial yield is a pretty good predictor of forward returns. You’re currently getting around 5% from high-quality bonds.
This is not bad.
Of course, this also means higher borrowing costs. Mortgage loan interest rates decreased to 6.7 percent.
There is no definitive answer regarding interest rate increases. Somewhat good. Some are bad. Some unknowns.
But higher bond yields, by themselves, do not necessarily spell disaster for the economy or the stock market.
Michael and I talk about rising government bond yields and much more in this week’s Animal Spirits video:
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Further Reading:
Can You Buy Bonds When There Are Bonds on the Street?
Now here’s what I’ve been reading lately:
Books:
Podcast book tour:
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