Bond yields in key markets around the world have been on something of a roller-coaster ride, moving up quickly in recent months. Ten-year Treasury rates closed at 2.28% on May 11, up from 1.65% at the end of January, according to Bloomberg.
In the same time period, yields on 10-year UK gilts jumped to 1.95% from 1.33%, while in less than a month, the yield on 10-year German bunds rose to 0.61% from a rock-bottom 0.08%. Even the yields on AAA-rated municipal bonds, traditionally less volatile, climbed to 2.07% from 1.72% in January.
These yield spikes are worrying many investors, since when yields rise, bond prices fall. But we’ve been expecting higher volatility in all asset classes—bonds as well as stocks. Indeed, we’ve been modestly underweighting bonds relative to their strategic allocations in client accounts that include our Dynamic Asset Allocation (DAA) service.
Why Are Rates Up?
US bond yields rose on signs of an uptick in inflation, one of several factors that will likely propel the Fed to raise policy rates later this year. In Europe, yields are escalating with signs that the economy is improving. In fact, some observers have been speculating that conditions may become good enough for the European Central Bank to slow the pace of its bond purchases.
Do higher bond yields spell bad news for investors? Overall, probably not. Rising rates often go hand-in-hand with improving economies. While bond values will be damaged in the short run, higher yields will mean more bond income longer-term—and provide a cushion for central banks to lower rates again if they’re faced with another crisis in the future.
What Should You Do?
Like stocks, bonds move up and down—though far less dramatically. We’re telling our clients to stay the course with their strategic bond allocations, tactically adjusted via DAA. It’s hazardous to change a strategic asset allocation every time the markets tremble.
Bonds are still playing their traditional role in a portfolio: providing regular income and helping mitigate stock risk, which in turbulent markets is far more damaging.
Keeping taxable and municipal bond portfolios anchored in high-quality securities with intermediate durations on average, will also promote portfolio stability.
The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AB portfolio-management teams.