Making Sense of the Bond Market

Telemus Weekly Market Review October 2nd - October 6th, 2023

On Friday bond yields shot up after employment data for the month of September indicated a stronger than expected labor market. This was interpreted as data that not only supported the Fed maintaining a ‘higher for longer’ interest rate posture but also offers the Fed ammunition to increase the federal funds rate (the interest rate they control) at their next meeting should they so choose.  

Since the end of August, yields offered on longer maturity Treasury bonds have aggressively priced in a higher for longer expectation. Over the past five weeks, the 10-year Treasury yield has increased by roughly three quarters of a percent (0.75%), a quick and swift movement in its yield. The 10-year Treasury is now offering its highest yield since 2007. For investors, this move has been bittersweet. On one hand, a higher yield improves the total return for investors purchasing the bond today and electing to hold it to maturity, thereby realizing what is presently a 4.80% yield. Alternatively, since bond prices move in the opposite direction of yields, prices on long-term Treasuries have had a challenging last month or so. 

The initial move higher in bond yields that began in mid-September was based on both a modest uptick in inflation during the month of August and the Federal Reserve noting it would hold rates at elevated levels into 2025 (and potentially beyond). The challenges Washington has faced in agreeing to a federal budget have added to angst as the creditworthiness of the U.S. is being called more into question. Not that the U.S. won’t be able to pay its bills, but that disfunction in Washington will impact the ability to manage the budget deficit, a growing concern among many investors. 

The rapid rise in long-term Treasury yields has been a surprise to most. We have long held the view that predicting interest rates, both direction and magnitude, is not something we’ve seen any investor do on a consistent basis. We also think a good portion of the recent movement makes sense given the higher for longer stance of the Fed and what we believe is a deserved added risk premium on U.S. Treasuries given legislative disfunction. Based on this we believe having balanced exposure to maturities across the yield curve is reasonable. 

It is tempting in the present environment to own short-term Treasuries, say two years and under, where you are compensated with attractive yields over 5% and bond values are less sensitive to any movement in yields. While this may be prudent for some investors, for others having some exposure to bonds longer than two years enables them to lock in the present yield in the event that rates move lower in the next year or two. 

To help illustrate this, we look back at mid-2007, the last time the 10-year Treasury offered a 4.8% yield and consider how rates moved. By March of 2008, roughly nine months lates, the yield on the 10-year Treasury had fallen to roughly 3.5%. Coincidentally there was a similar move back in June of 2002, when the 10-year Treasury provided a yield of 4.8%, wherein three months later the also approached 3.5%. This time around, we don’t necessarily expect a quick move in rates lower, but one can’t consistently forecast events that will require a flight to safety or an unexpected economic shock. 

We believe that both short- and longer-term interest rates offer a reasonably attractive yield at present levels. Certainly, as markets grasp with monthly data around inflation and employment, along with every evolving movement in expectations out of the Fed, Treasury yields will continue to move up and down. However, given where rates are currently offered on Treasuries, we believe that bonds offer reasonably attractive yields regardless of whether an investor is comfortable owning just short-term or broader range of maturities. 

While the concept of bonds may seem straight forward, the nuances of bonds are complex. One must consider how much exposure to bonds you should have, what range of maturities to own, whether you should own taxable of municipal bonds, and how to think about any near-term movement in yields. As you wrestle with these topics, we encourage you to give us a call. We’re here to help navigate the more nuanced complexities of the bond market.  

All opinions expressed in this article are for general informational purposes and constitute the judgment of the author(s) as of the date of the report. These opinions are subject to change without notice and are not intended to provide specific advice or recommendations for any individual or on any specific security. The material has been gathered from sources believed to be reliable, however Telemus Capital cannot guarantee the accuracy or completeness of such information, and certain information presented here may have been condensed or summarized from its original source. PAST PERFORMANCE IS NOT A GUARANTEE OF FUTURE RESULTS. Investment decisions should always be made based on the client's specific financial needs, goals and objectives, time horizon and risk tolerance. Current and future portfolio holdings are subject to risk. Risks may include interest-rate risk, market risk, inflation risk, deflation risk, currency risk, reinvestment risk, business risk, liquidity risk, financial risk, and cybersecurity risk. These risks are more fully described in Telemus Capital's Firm Brochure (Part 2A of Form ADV), which is available upon request. Telemus Capital does not guarantee the results of any investments. Investment, insurance and annuity products are not FDIC insured, are not bank guaranteed, and may lose value. Any reference to an index is included for illustrative purposes only, as an index is not a security in which an investment can be made. Indices are unmanaged vehicles that serve as market indicators and do not account for the deduction of management fees and/or transaction costs generally associated with investable products.  The S&P 500 index includes 500 leading companies in the US and is widely regarded as the best single gauge of large-cap US equities.

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