Are Rising Treasury Yields Set to Squash Bond Funds?

It’s no secret that Treasury yields plunged into the basement in 2020.

Back in the spring of 2020, the Federal Reserve slashed key interest rates to near-zero. The federal funds rate currently stands at 0% to 0.25%. The Fed has also stated that it will maintain its ultra-low interest rate policy through 2023 and plans to purchase $120 billion worth of bonds per month until inflation rises above its 2% target level.

Now, when the Fed cut interest rates to near-zero in March 2020, government bond yields fell through the floor. The 10-year Treasury plunged from its mid-February 2020 highs of about 1.64% to an early August 2020 low of 0.51%.[1] Clearly, the start of the COVID-19 pandemic in the U.S. sent droves of fearful investors into the safety of government bonds. So, U.S. Treasury yields plunged to all-time lows.

It has been a different story since. Over the last six months, interest rates moved higher. According to Yahoo Finance, the 10-year Treasury yielded just over one half of one percent six months ago. Today the yield on the 10-year Treasury is at 1.14%.

That’s a big jump, and the impact on all things bond fund related has been noticeable. Take the iShares 10–20-year Treasury Bond ETF. Six months ago, the net asset value of this fund was at $167.11 per share. Today the net asset value sits at 149.07.

Why does this matter? Because it’s supposed to be your ‘safe’ money.

Unlike owning individual bonds that can be held to maturity, bond funds must be sold to get at the principal. That means depending on the timing of your withdrawal, you could be out of luck in terms of how much principal you get back.

That’s an uneasy situation for those that require cash flow certainty concerning their retirement plans. Rising interest rates will negatively impact a bond fund's net asset value, which can result in an investor falling short of their goals and objectives.

Owning a bond that matures on a date whereby the cash is needed according to a person’s specific plan will fluctuate in price too, but that price is irrelevant for those intending to hold a bond to maturity – which, by the way, is what a bond investment was intended for in the first place.

The reality is that bonds tend to perform well in periods of declining Treasury yields, which is why many income investors poured into high-yield corporate and government bond funds last year. But, in my opinion, bond funds aren’t a “safe” investment. They are quite risky.

Here’s what we need to understand about bond funds: While the underlying investments—bonds—are appropriate for individual investors, bond funds can fall short in many ways. Bond funds are pooled investment portfolios that cannot be invested with any single investor’s specific financial goals in mind. And some of these bond funds don’t only hold bonds; they can pick up bonds or other securities, regardless of credit quality or country of issue, as well as currencies and, in some cases - even stocks.

So, bond funds aren’t necessarily a good bet for all investors, especially now that yields are so low and starting to rise.

Treasury yields are no longer at basement levels. The 10-year Treasury is back to levels not seen since March 2020. The 10-year Treasury has a current yield of about 1.2%. The 30-year Treasury is also back to its February 2020 highs, sitting around 2.0%.[2]

The rollout of the COVID-19 vaccine, the promise of another stimulus package, and the lifting of lockdown restrictions in states like California have created more hope on Wall Street. We may finally come to the other side of this global pandemic. As a result, investors’ risk-appetite has come back a bit, as they exit Treasuries and tiptoe back into stocks.

Rising yields appear to tempt some investors into making adjustments to their portfolios. But making changes based on short-term shifts on Wall Street, whether it’s adjusting your fixed-income allocations or deciding to invest in more equities, can increase your exposure to incremental risk.

To help you determine if your current portfolio and investment strategy are aligned with your personal and investment goals, as well as capture the opportunities presented by the current market environment, I encourage you to reach out to us at Nicollet Investment Management today. We’d be happy to discuss bond funds, fixed-income strategies, the rising rate environment, and how they relate to the broader investment landscape.

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[1] https://www.marketwatch.com/investing/bond/tmubmusd10y?countrycode=bx

[2] https://www.reuters.com/article/us-usa-bonds-markets/explainer-what-rising-bond-yields-mean-for-markets-idUKKBN2A82AC