The Good News in the Bond Market: Starting Yields Mean Better Forward Returns

The Good News in the Bond Market: Starting Yields Mean Better Forward Returns

Bond yields have surged over the last six months, making waves for financial markets at large, but also improving prospects for bond market returns going forward. After years of struggle following extremely low yields of less than 1% during the pandemic, today's starting yields over 5% for most tenors put bonds in a better position to generate attractive returns and improve the outlook for fixed-income investors. This is because starting yields are an indicator of potential returns for bonds, while they provide a degree of cushion against rising interest rates. Even if rates continue to rise from current levels, the rise in yields should will have a more muted negative impact on bonds' total return.

For the First Time Since 2007, Starting Yield is Over 5%

Starting yields have historically been a useful indication of longer-term potential returns for fixed income. While the relationship between starting yields and subsequent 1-year returns can be influenced by shorter-term factors, such as changes in interest rates and credit spreads, the correlation strengthens over longer time horizons. Over longer holding periods, income and coupon reinvestment become increasingly more significant drivers of total return, reducing the influence of shorter-term price fluctuations and allowing the initial yield to more closely reflect the potential return for investors.

100 Basis Point Move in Yields Will Cause Less Pain with Yields at 5%

Even if rates continue to move higher from here, the starting yield of 5% offers investors income to offset the price decline that occurs as rates move higher, improving the total return prospect for bonds. For a bond with six years of duration, the price impact of a 1% increase in yields would be similar across starting yield levels; however, at lower starting yields, less coupon income is available to help offset the price decline, resulting in more significant impact on total return. Conversely, higher starting yields provide additional income to help offset and improve the potential total return.

Disclosure: HB Wealth is an SEC-registered investment adviser. The information reflects the author's views, opinions, and analyses as of the publication date. The information is provided for informational purposes only and does not constitute an offer to sell or a solicitation of an offer to buy any investment product. This information contains forward-looking statements, predictions, and forecasts ("forward-looking statements") concerning beliefs and opinions with respect to future events and market conditions. Forward-looking statements involve risks and uncertainties, and undue reliance should not be placed on them. There can be no assurance that forward-looking statements will prove to be accurate, and actual results and future events could differ materially from those anticipated in such statements. The information does not represent legal, tax, accounting, or investment advice; recipients should consult their respective advisors regarding such matters. Certain information herein is based on third-party sources believed to be reliable but which have not been independently verified. Fixed-income investments are subject to interest rate risk, credit risk, and market risk. Historical relationships between starting yields and subsequent returns may not persist in future market environments. Past performance is not a guarantee or indicator of future results; inherent in any investment is the risk of loss.