Bonds represent safety and stability to most investors — but with questions over the future of monetary policy and demand for income-generating products, are they still ballast for portfolios?
As the U.S. Federal Reserve searches for ways to raise interest rates, bonds can no longer be assumed to be safe havens, says Dave Haviland, a relationship manager at Needham, Mass.-based Beaumont Capital Partners.
Haviland argues that a spike in interest rates could lead to a selloff in bonds, possibly setting off a liquidity event or a long-term bear market across fixed income.
“It could come as a shock to a retiree relying on their portfolio to give them income if all the sudden they open their statements and see their bond funds have had significant losses,” Haviland says.
Bond markets have become especially volatile as of late, with yields on the 10-Year Treasury, often considered a paragon of stability, moving from around 1.36 percent in early July to well over 1.6 percent in early September — signaling a fall in bond prices.
Much of the volatility surrounds the will-they, won’t-they speculation around whether the Federal Open Market Committee will raise interest rates at its meeting later in September. Currently, the market does not expect an increase: Federal-funds futures still place the likelihood of a rate hike at around 30 percent.
Haviland posits that if the Fed were to begin raising rates with the markets unprepared, the response from investors could create a cascade of bond selling.
“If all of the sudden there was a bond sell off, it could trigger a concurrent equity sell-off as these models start seeing valuations that are less compelling and they start selling,” Haviland says. “I don’t believe this is imminent, but the concept is certainly there. Our concern is that a rise, even a modest rise in interest rates could have oversized events on both the bond and the stock markets.”
As interest rates and returns have declined, investors have chased higher-yielding products, allowing additional risk into their fixed income portfolios by assuming longer durations or accessing lower-quality credit.
“People have been forced up the risk spectrum by the central banks,” says Jeff Kilngelhofer, a portfolio manager on the fixed income team of Santa Fe, N.M.-based Thornburg Investment Management. “The Fed intentionally pushed down the yields of risk-free assets in hopes that pushing investors out on the risk spectrum would spur a circular environment of growth, and to some extent they’ve been successful.”