We’ve discussed the August stock market update, but what about the bond market, or “fixed income,” as it’s also known in financial industry jargon?
Interest rates have risen significantly over the past year and a half, as the US Federal Reserve and central banks around the world have worked to contain inflation. When interest rates rise, bond prices decline, and when rates fall, prices increase (we’re happy to explain this relationship in more detail to anyone who’s interested). This is why bond prices declined so much in 2022 (down 11% for Vanguard’s intermediate-term bond fund), when the benchmark 10-year Treasury rate increased from 1.5% to 3.88%.
This year has been a somewhat different story. Rates have risen further, to 4.09% as of the end of August. So prices have declined, but the offset is that investors are now earning interest at the higher rates. The combination of more interest and slightly lower prices has resulted in gains of about 2% for Vanguard’s short-term and intermediate-term bond funds, and more than 5.5% for the high-yield bond fund.
There are, however, fixed income alternatives that are not subject to price declines as rates rise. These include “purchased” money market funds (PMMFs), which maintain a steady $1 per share price and currently yield in the 5.25% range. You can also buy short-term Treasury bills, which are yielding about 5.45% (for three-month terms) and 5.5% (for six-month terms). As long as you hold these Treasuries to their short “maturity” dates, there are no price declines. By contrast, the yield on the Vanguard bond funds are currently in the 5% range.
At the beginning of 2022, when PMMFs and short-term Treasuries had rates close to zero, there was no question for PPA that the fixed income portion of a diversified portfolio should be invested in bond funds, which were yielding 2-3%. Now, with short-term rates higher than longer-term ones (a situation known as an “inverted yield curve,” which we’re also happy to discuss further if you’re interested), it’s a tougher call. As you know, we never recommend trying to time the markets (in this case, selling all your bond funds to buy PMMFs). But if you have cash available for investment in fixed income, it’s likely to make sense to consider, in consultation with your advisor, a mix of PMMFs, Treasuries, and bond funds.
We will continue to monitor these changes in the markets and are always happy to discuss how they relate to your specific situation.