If this is the beginning of a bear market in bonds, however, it is unlikely to be a very long or painful one. Already, the 10-year yield has dropped back to 2.8 percent — largely as a result of President Donald Trump’s desire to initiate trade wars.
“I don’t consider this a bear market,” said Matt Diczok, head of fixed-income strategy for Merrill Lynch and U.S. Trust. “There’s been an acceleration in economic growth, but inflation lags the economy and we see interest rates trending only slightly upward from here.”
Diczok expects the 10-year Treasury bond to trade within the range of 2.78 percent to 3.38 percent this year, likely finishing above 3 percent by year-end. “I don’t expect a big rate shock from here,” he said.
Nevertheless, rising rates always hurt fixed-income investments — floating-rate instruments being the exception. As interest rates rise, the prices of existing bonds fall in order to make the yield of their fixed coupons competitive in the market. After decades of generally declining rates and capital gains on bonds, investors may actually experience losses in 2018.
That doesn’t mean you should liquidate your fixed-income portfolio. Bonds remain the most important asset to diversify the risk of owning stocks. While most market analysts expect rates to rise from here, nothing is guaranteed, and when the stock market has its next 10 percent dip, you’ll be happy for your bond holdings.
“When you build a portfolio, you don’t put 100 percent of your money into the highest-returning asset,” Diczok said. “We guess about where the economy and markets will go, but things we never thought possible can happen.”