9 Reasons Bond Yields Are Going Higher (October 2023)
And what smart investors can do about it
This is October 2023. And there are many reasons that investors are pointing to as the reason for rising bond yields. With the price action and volatility in the last few weeks, bonds are no longer a low-risk investment.
First, let's consider the several reasons bond yields are rising and price is falling:
1. More Supply
The best argument I have seen thus far is this one about supply. How do you expect bond yields to stay down when new ones are entering the market every day?
The US government is creating new bonds every day. That is a fancy word for "borrowing money". Bonds are debt obligations by the government.
This is a classic case of demand and supply. If the demand remains the same and you keep increasing the supply, the price is bound to fall. And when the price of bonds falls, the yield goes up.
2. China and Japan are Selling
In recent history, China and Japan have been huge buyers of US bonds. At some point, they both held over 25% of the total supply of US bonds. But in recent years, they have been net sellers.
The economic relationship between China and the US is fractured. And Japan has domestic economic issues of its own. And so both are net sellers of US bonds.
3. The Federal Reserve is Selling (QT)
During the economic crisis of 2008 and 2020, the US Federal Reserve (which is the central bank), took on a lot of US bonds into their balance sheet to help provide liquidity for the struggling economy.
Now, their balance sheet is overloaded with debts (which is not supposed to be). This gave rise to the inflation problem. So, one of the ways to dampen the inflation problem is to eject liquidity from the system. And the way for the Fed to do that is to sell bonds. (And they have a lot to sell).
They call this process quantitative tightening (QT). The Fed used to be a huge buyer of bonds (under the quantitative easing program). Now they are a net seller too.
4. No Safe Haven Status Anymore
Investors used to look to bonds to avoid the heavy blows of a recession. But recently, bonds do not correlate inversely to stocks anymore.
This means when stocks go up, bond prices go up. When stocks are down, bond prices are down too. This makes investors who want to diversify their portfolio look elsewhere.
In the past, if stocks are down, bond prices are up. But that is not the case anymore. Stocks and bonds get hammered at the same time. So, investors who would usually buy to hedge their stocks portfolio are not really doing that now.
5. US Government Distrust
Trust in the current administration of the US is at an all-time low. The government is very irresponsible with spending. The debts are growing at alarming rates. Inflation is persistent.
In the last couple of weeks, Congress has struggled to pass a long-term funding bill. The country is divided on a fiscal and ideological basis. And there is significant risk there.
There is a very low confidence in the lawmakers, the current president and the entire government. A lot of people are actually angry with the economic state of things. And that angry group is gradually growing to become a majority.
In all of this, the government is still going into debt to the tune of billions per day. The USA has a net trade deficit. And their energy independence status is shaky.
A lot of the money that the US government is borrowing is not even doing anything to increase the government's revenue. For example, there is the war in Ukraine and student loan forgiveness.
If the government is borrowing money to pump it at things that don't generate more revenue for the government, then it is just a matter of time before the debts become impossible to pay back.
Currently, the debt of the US exceeds the GDP. And the government has to borrow to meet up with the interest payments as it stands. So, the system has a credibility problem.
7. Interest Rates
This has the most direct impact on bond yields. When the Fed (that is, the central bank) increases the cost of borrowing money, it affects government borrowing too.
The government has to borrow at those high rates that the central bank has set. And so, ideally, the government cannot borrow money at a rate lower than the set interest rate by the central bank.
8. Bond Yields Expected to Go Higher
Both the bosses of JP Morgan and BlackRock have hinted that the bond yields will go higher. Jamie Dimon of JP Morgan says the interest rate is going to 7%. Currently, this is in the 5.5% range.
Larry Fink hints over 5% for the 10-year yield. As of writing, the 10-year yield is around 4.8%.
This is making investors say things like, "When it goes higher, we will buy". (When bond yield goes higher, the bond price goes lower). But what good is a higher yield if the fundamentals to pay it back are not there?
9. Inverted Yield Curve and Fears of a Recession
When you plot a graph of bond yields (in percentage) on the y-axis and year to maturity on the x-axis, you get what is called a yield curve.
In a normal economy, the curve is supposed to be a kind of "n" shape or some variant of that. But the curve is called inverted when it has a "u" shape.
This "u" shape curve is often a sign that something is wrong with the economy or there is a recession in sight.
You can easily tell the curve is inverted when the 30-year yield is higher than the 10-year yield. At the same time, the 2-year yield is also higher than the 10-year yield.
This economic uncertainty, coupled with everything happening makes things harder to predict for investors. At the same time, the Fed is hiking interest rates (which is increasing the cost of borrowing money).
What Should Investors Do With Bond Yields Going Higher?
This is not financial advice. Personally, I do not see the sense in buying US bonds for now. And I have been an advocate of getting out of the bond market (before now).
If I have a portfolio of about 100 billion or more, maybe I would be buying. That's because, with that size, I guess I can be in the room where decisions are made. But with just a couple of millions or less, it is very easy to get screwed.
It doesn't make sense for anyone who owns bonds to sell now. This is a bad time to sell. Maybe you should diversify your investments into other things to take the pain. Hopefully, the issues will get resolved. Plus, you still have the yield bringing you cashflow.
While I don't think it is a good place to buy for several reasons, I also do not think it is a good time to sell. If you can, hold your position. Just my perspective and opinion though.
Is it a good time to short bonds? Depends on if you can stomach the risk. I hear some brave souls are doing that right now. But I wouldn't.
9 broad reasons explain why bond yields are rising:
1. More supply
2. China and Japan are selling
3. The Federal Reserve is selling (QT)
4. No safe haven status anymore
5. US government distrust
7. Interest rates
8. Bond yields are expected to go higher
9. Inverted yield curve (and recession fears)
P.S. To truly diversify your investing portfolio, take a look at this discourse on US equities