Hoxton / Sam Edwards | Getty Images
Bond yields jumped this week after another big interest rate hike by the Federal Reserve, which led to a warning of market distress.
The policy-sensitive two-year Treasury yield rose to 4.266% on Friday, hitting a 15-year high, and the 10-year Treasury yielded 3.829%, an 11-year high.
The higher yields come as markets weigh the effects of federal policy decisions, with the Dow Jones down nearly 600 points in bear market territory, dropping to a new low for 2022.
A yield curve inversion, which occurs when short-term government bonds have higher yields than long-term bonds, is one indicator of a possible recession in the future.
More personal finance:
Inflation and higher rates are a “dangerous combination” for consumers
marriage? How do you know when to collect your money
New retirees may face additional fees for Medicare premiums
“High bond yields are bad news for the stock market and its investors,” said certified financial planner Paul Winter, owner of Five Seasons Financial Planning in Salt Lake City.
Winter said higher bond yields create more competition for funds that would otherwise go to the stock market, and with higher bond yields used in the calculation to value stocks, analysts may reduce projected cash flows in the future.
Moreover, issuing bonds to buy back shares may be less attractive to companies, and it’s a way for profitable companies to return cash to shareholders, Winter said.
Fed increases contribute ‘somewhat’ to higher bond yields
Market interest rates and bond prices usually move in opposite directions, which means that higher rates lead to lower bond values. There is also an inverse relationship between bond prices and yields, which rise as bond values fall.
Winter said the Fed rate hike has somewhat contributed to higher bond yields, with the effect varying across the Treasury yield curve.
“The further away you are from the yield curve and the lower the credit quality, the less impact a Fed rate hike will have on interest rates,” he said.
That’s a big reason for the inverted yield curve this year, he said, as two-year bond yields have risen significantly more than 10- or 30-year yields.
Review stock and bond allocations
John Olin, CFP President and CEO, Ulin & Co. Wealth Management in Boca Raton, Florida It’s a good time to reconsider your portfolio diversification to see if changes are needed, such as reorganizing assets to match your risk tolerance.
On the bond side, advisors monitor the so-called duration, and measure the sensitivity of bonds to interest rate changes. Expressed in years, the factors of the term in the coupon, the time to maturity and the return paid during the term.
While clients welcome higher bond yields, Olin suggests keeping tenures short and reducing exposure to long-term bonds as interest rates rise.
“Term risk may wipe out your savings over the next year, regardless of sector or credit quality,” he said.
Winter suggests tilting stock allocations toward “value and quality,” typically trading below the value of the asset, on growth stocks, which might be expected to provide above-average returns. Oftentimes, value investors are looking for companies that are undervalued and that are expected to rise over time.
“Above all else, investors must remain disciplined and patient, as always, but more specifically if they believe rates will continue to rise,” he added.