Market volatility paves the way for costlier loans and higher returns for savers from secure investments
Treasury yields jumped, then plunged sharply, and began rising again, as investors reacted to government borrowing, inflation, the war in Iran, and uncertainty surrounding Federal Reserve policy.
Although bonds are not supposed to be a source of dramatic volatility in an investor’s portfolio—indeed, they are meant to be safe and entirely uneventful—the bond market’s sharp moves this week were the exact opposite.
For your money, the most important story is the level at which yields settle. Analysts say they may remain elevated for some time in the longer term, potentially paving the way for a world where borrowing is more expensive, yet savers can earn higher returns from safer investments.
For homebuyers, even modest increases can significantly raise costs. A $500,000 mortgage over 30 years at a fixed interest rate of 6.67% would cost an additional $225 per month, or nearly $3,000 annually, in principal and interest compared to 5.98%, the lowest rate seen so far this year.
This could represent a more durable shift for individual investors, and what should be taken into account is that borrowing costs may remain high, particularly for mortgages.
In general, higher Treasury yields lead to higher mortgage rates. Bond market volatility can also add another layer of cost for borrowers.
Mortgage rates tend to move in tandem with the 10-year Treasury yield, as both reflect the cost of borrowing money over a long period. Although most U.S. home loans are 30-year mortgages, many are paid off much earlier when people move or refinance, making their actual duration closer to that of 10-year Treasuries.
Volatility can push mortgage rates even higher, as lenders and investors demand an additional safety margin in the face of uncertainty regarding inflation, interest rates, and how long borrowers will hold their loans. This means mortgage rates may remain high, or even rise, when Treasury yields fall, especially when markets experience sharp swings.
Buyers seeking a mortgage interest rate should compare offers from multiple lenders and focus on the monthly payment they can comfortably afford, rather than trying to time a drop in interest rates.
It may be worthwhile to adopt other strategies to lower mortgage interest rates. Adjustable-rate mortgages may suit buyers who expect to move or refinance before the fixed-rate period ends, while paying points is generally more attractive to those who plan to keep the loan long enough to recoup the upfront cost.
Although mortgages are particularly sensitive to the bond market, interest rates on credit cards, many other loans, and savings accounts are more heavily influenced by Federal Reserve policy and short-term interest rates. Nevertheless, borrowers should be prepared for interest rates to change quickly when seeking other types of credit.
The repercussions of rising bond yields can extend to other markets. If investors can earn higher returns from relatively safe government bonds, their incentive to take on the same level of risk in stocks diminishes.
For investors, the takeaway is not to abandon stocks, which remain important for long-term growth. However, higher yields may make bonds worthy of reconsideration as a source of income and diversification.
Gold also warrants attention, given its traditional role as a safe haven during periods of market stress. Rising Treasury yields could make the precious metal less attractive, as investors can achieve higher returns by holding government debt, whereas gold pays no interest.
This relationship may break down when investors grow concerned about inflation or broader financial risks, such as a weakening dollar, which could boost demand for gold even if yields remain elevated.
For savers, rising yields on long-term Treasury bonds do not automatically translate into improved bank interest rates. Savings accounts are more closely tied to Federal Reserve policy and short-term interest rates, although banks may offer higher yields on deposits if the Fed keeps rates high.
The national average interest rate on savings was just 0.38 percent as of August 18, according to Max, a fintech company that helps savers move their money between bank accounts offering higher yields. Many of the largest banks have barely raised their rates, even as the Federal Reserve aggressively hiked interest rates after the pandemic.
Savers can still find competitive yields in high-yield savings accounts, money market funds, certificates of deposit (CDs), and short-term Treasury bills, even if long-term yield increases are not reflected in their bank accounts. Locking funds into a CD or short-term Treasury bill entails interest rate risk; if short-term rates rise, savers may miss out on higher yields elsewhere. However, banks typically adjust deposit interest rates by only about 15 basis points for every 25-basis-point move by the Federal Reserve, according to Zimmermann’s research.
Interest on Treasury bonds is exempt from state and local taxes, so savers comparing Treasuries to CDs or savings accounts should compare after-tax yields. However, investors who need their money before maturity may incur a loss if they sell after interest rates have risen.
Rising yields may mean losses for investors who already hold bonds, but it is good news for those buying bonds now, and the right choice depends on your time horizon. Investors who do not want to bet on yields peaking can spread their purchases across bonds with different maturities, a strategy known as a “ladder.” This allows them to lock in some of today’s yields while regularly freeing up cash to reinvest if interest rates rise. Exchange-traded funds (ETFs) that hold bonds with varying maturities have also emerged, such as the Vanguard Total Inflation-Protected Securities fund.
Rising yields also present an opportunity for some retirees to rebalance their portfolios. Advisors warn against making large portfolio shifts merely to chase higher yields, likening the attempt to time these moves to “trying to catch a falling knife.”
