Bond yields are back, Daniel B. Berkowitz has been telling clients at Philadelphia-based Prudent Asset Management, which manages $1 billion for investors including Congregation Rodeph Shalom and family-business owners.
Both stock and bond values plunged last year as the Federal Reserve boosted interest rates, leaving retail investors with fewer places to hide.
But now the rates government and businesses are paying to raise money by selling new bonds have risen many percentage points. They are much higher than the near-record lows of recent years. These higher yields make the bonds attractive to investors.
"Bond yields are now materially higher," said Berkowitz, investment director at Prudent. "It's 15 years since we've had yields in this range."
To be sure, "getting to this point was painful," Berkowitz said. "But the end result of where we are today is a higher prevailing level of interest rates," which has attracted worried investors back to bonds and bond funds. "That suggests a better forward-looking return for those who hold fixed income in their portfolios."
As inflation shows signs of calming, bonds could end up building value for investors faster than inflation erodes their savings.
But "clients are still nervous," said Fred Snitzer, managing director of family-owned Prudent. "They see what's happening out in the world."
To be sure, as values plunged in 2022, client fears "never got as bad as 2008 — (when) there was abject panic — or the worst of COVID," Snitzer added. "This was more sadness and frustration when both stocks and bonds were declining. "
Berkowitz added: "People felt they were doing things right, but not getting rewarded."
Will today's rates last? When rates are stable, longer-term debt, such as 10-year Treasury bonds, typically pay more than short-term bonds, as a reward for tying up investors money. But at present bonds are showing what fixed-income wonks call an "inverted yield curve," with shorter-term government bonds paying more than longer bonds, a sign investors expect the economy will slow, and bond yields will drop, in the foreseeable future.
For now, some of the biggest investment houses are nudging investors toward bonds. Government securities look "risk-free," compared to stocks, which by contrast are now favored by only the "very bullish," JPMorgan told investors Monday.
"Diversify your investment and generate income with a less risky alternative to stocks," Malvern-based Vanguard Group trumpets on its bond investment home page.
Even with this year's modest recovery, "there's still tremendous uncertainty in the market," Snitzer warned. Fed "aggression" and bank "turmoil" will still likely make for a "bumpy ride" in the next couple of years.
Prudent puts most of its clients' money in mutual funds, split about 60-40, stocks and bonds.
Bonds from high-rated government and corporate issuers are considered safe against loss, even when their value goes down, because investors are promised interest until their term expires and investors have their principal and promised interest back.
But the Silicon Valley Bank collapse reminded investors that depressed bonds can hurt their owners, if they need cash so badly they have to sell them at a loss, as the bank did after investors withdrew billions in deposits.
Aren't bond funds similarly vulnerable to that kind of run? "You could make the same argument for private investments at big investors like the Pennsylvania pension funds," which in a long recession can be forced to mark down real estate and other private investments — a danger banks also face as recession drives down property values, Berkowitz said.
There were plenty of bond sellers and bond-fund sellers as rates rose last winter, he acknowledged. But many of those investors wrote down those low-yield bond losses against taxes on earlier profits, then bought bonds again as yields rose in 2023.
What's good for bond investors — high rates — isn't so good for the economy as a whole, Berkowitz said.
"Interest expenses are going up. There may be an impact on earnings. And commercial real estate, that's a tough one," he said. "The smaller regional banks hold a lot of commercial real estate debt. They are exposed if the banks have to liquidate these positions at unfavorable prices. They could need more government intervention."
Watching the Fed
Banks and credit unions are paying more on their deposits now, Berkowitz noted. In part that's because they are having to compete with those rising bond yields.
Banks profit from the gap between what they pay depositors (and the Fed) for funds and what they charge borrowers in loans and fees (at least until borrowers stop paying back a lot of loans, which happens in a severe recession, or when a bank has been especially careless).
The Federal Reserve is now in the reverse position: As a way of helping banks avoid a crisis after the Silicon Valley and Signature failures, it is now paying commercial banks nearly 5% on reserves they park with the Fed — while holding onto its own multitrillion-dollar portfolio of older bonds, including Treasuries and banks' mortgage-backed securities, that is only yielding it around 2%, said Robert Eisenbeis, chief monetary economist at Cumberland Advisors, which is based in Vineland, N.J., and Sarasota, Fla., in a report to clients.
Like Silicon Valley Bank, most of the Fed's bonds don't mature for at least five years, and half have more than 10 years to go — so the central bank is stuck receiving very low yields, even as it guarantees higher rates to commercial banks.
The Fed can do this, for now, only because government accounting rules allow it to delay recognizing those losses, Eisenbeis said.
As a bank, the Fed has "negative real equity" and will take years, if ever, to regain profitability, which limits its power to more effectively fight high inflation, said veteran banking analyst Richard X. Bove, of Odeon Group in New York.
None of which matters to investors weighing whether bonds yield enough that they should buy more instead of betting on stocks.
How long can this last? "It does seem like a good time to buy bonds, but I don't know that bonds are likely to go much higher," said John Sedunov, professor of finance at Villanova.
"If you're interested in holding bonds til they mature, you will do well with interest rates, right now. But if you're looking for capital appreciation, there's not much more room for rates to rise," Sedunov said. "It should be viewed as a short-term thing."
What the Fed has boosted, it can as easily cut, once its governors think inflation has receded, and recession is upon us. When it comes to higher bond yields, "I can't see it sticking for a long time," Sedunov concluded.
