Interest rates have been rising since July, and investors have stormed out of bond funds in fear of the most widely anticipated
bear market in history. How bad has the carnage been so far?
Not so bad.
The 10-year Treasury note yield hit 1.366% on July 8, the lowest level since the bellwether note was first issued in 1962. It has since bounced back to 1.80% — a steep rise, but well below its yield of 2.269% on Dec. 31, 2015.
Nevertheless, that's a big jump, and when bond yields rise, bond prices fall. At current low levels, the amount of interest investors get from bonds probably won't offset price declines quickly.
And a few bond exchange-traded funds have, indeed, been smacked by rising rates. Vanguard Extended Treasury Duration ETF (EDV), for example, has fallen 11.27% since July 8, including reinvested dividends and despite the fund's low costs. The average long-term government ETF is down 7.27%.
On the other hand, the largest U.S. bond ETF, Vanguard Total Bond Market Index ETF (BND), has fallen just 1.08%. And other popular categories haven't seen much bloodshed. Intermediate-term bond ETFs are down a median 0.62%, according to Morningstar. Corporate bond ETFs have fallen 0.12%.
And a few types of funds have done quite well: High-yield bond funds are up 2.99%.
Despite the relatively benign performance of both indexed and actively managed funds, however,
investors yanked $2.2 billion from junk bond ETFs last week, according to XTF, which tracks fund inflows. High-yield funds saw a $67 million total outflow in September, according to Morningstar.
Friday's jobs report gave some credence to worries about a stronger economy and higher inflation. The economy created 161,000 jobs in October, which is a good number, but below the average of the last few months, noted Nariman Behravesh, chief economist for IHS Markit. And all the job gains were in the lower-paying service sector.
Nevertheless, average hourly earnings rose 0.4% month-over-month and 2.8% year-over-year. You can't have a wage-price spiral without higher wages, and for inflation hawks, the increase in wages is worrisome.
But wages are hardly rising rapidly. “I think it's good,” Mr. Behravesh said. “Higher wages help consumer spending. And there is still a fair amount of slack in the labor market.”
The difference between the Labor Department's U3 unemployment — the so-called headline number — and U6, the more inclusive measure, still indicates about 1.5 million part-time workers who would like to be full-time employees.
The
Federal Reserve is expected to raise short-term interest rates at its December meeting, which would put the key fed funds rate at 0.50% to 0.75% from its current 0.25% to 0.50%. That's a level that's not going to kill the bond market or consumers. “Historically, it's not a big deal,” Mr. Behravesh said.
Bond managers have been predicting higher rates for several years now. The National Association of Business Economists predicted in 2015 that the 10-year T-note would yield 2.95% in the fourth quarter of 2016.
Jeffrey Gundlach, DoubleLine's bond king, warned in September that it's time for bond investors to prepare for higher rates and inflation. He predicted that the 10-year T-note yield would top 2%.
Given that the 10-year Treasury note's July yield was lower than at the depths of the Great Recession, it probably is a good bet that sooner or later, rates will rise and bond prices fall. But it could be a long, slow rise, given that there's plenty of deflationary pressure in Europe and China.
And you don't have to go abroad to find inflation, says John Lonski, managing director and chief economist for Moody's Capital Markets Research Group. “In certain sectors, you might be looking at lower prices,” Mr. Lonski said. “Wherever you have tradable tangible assets, prices are down: Motor vehicles, appliance and apparel.” In fact, durable good prices in general seem to be falling. “Inflation fears are grossly exaggerated,” Mr. Lonski said.
