What to Make of the Bond Market Rout
The U.S. is now paying its highest interest rates on long-term debt in decades, but there is no rush to the exits. Here's what this means for investors.
Bonds are suffering a rough spell, but this is not 2022, when fixed-income investments disgorged more than 10%. Even after several losing weeks, and despite palpable pessimism about whether the Federal Reserve and U.S. Treasury have answers to the darkening inflation picture, the Bloomberg U.S. Aggregate Bond Index is off less than 1% for the year through August.
Uncle Sam is now paying its highest interest rates on long-term debt in roughly 20 years, but the trading action in Treasuries is more drip-drip-drip than a rush to the exits. When bond opportunities arise, there are buyers. Alphabet (GOOGL) set off a stampede when it issued new debt at 4.875% for five years and 5.45% for 10.
However, medium-term and long-term fixed-rate investments have massive competition. Cash and ultra-short bonds pay 4%. Then come the newfangled and alternative ways to collect 5% and up: funds of variable-rate loans, options-driven income exchange-traded funds, high-rate credit and more.
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Back in the day, those were unknown, inaccessible to small investors or cost a fortune in fees and commissions. Now, says Bill Merz, the head of capital markets research for U.S. Bank, alternatives and floaters are serious rivals to traditional bond markets and a factor in forcing yields higher, alongside inflation, the Treasury's mounting debt and a lack of confidence in the government's plans and performance.
Bond owners have three motivations: income, diversification and capital preservation. As higher rates gnaw away at principal, it is sensible to review how best to serve each of these aims. I don't advocate a total portfolio teardown. Municipals are in the green in 2026 and are keepers if your tax situation makes the numbers work.
High-yield bonds continue to outperform investment-grade corporate and government debt. But when you can get 4% with no risk, or much more with only a little risk, it pays to look around.
Where to find income
The Fed raised short-term rates in September and is likely to raise again by the end of the year. This means variable-rate credit tied to the Fed will churn out more cash.
Funds including Fidelity Floating Rate Income (FFRHX), Janus Henderson AAA CLO ETF (JAAA) or PGIM AAA CLO (PAAA), and WisdomTree Floating Rate Treasury Fund (USFR) are outpaying and outgaining most bond funds, with high yields and year-to-date total returns of 4% and above — and that is before any rate hikes.
Use options-powered ETFs to diversify your portfolio
Unlike past economic cycles, long-term bonds and stocks are moving in the same direction. So, for insurance against a stock market correction or prolonged bond rout, it is logical to pursue high cash distributions that can offset price declines.
This explains the appeal and success of options-powered ETFs, such as Calamos US Equity Autocallable Income (CAIE) and two from Global X: NASDAQ 100 Covered Call (QYLD) and S&P 500 Covered Call (XYLD).
I would ignore the flaw that the options limit the growth from rising share prices and instead consider these to be high-yield income sources, not part of a stock allocation. I grant that these are complex. But they are paying out roughly 10% and more, and without interruption.
The best way to preserve capital
The surest way to guarantee that your savings stay intact is to lock them away. As the Fed tightens, money market funds and short-term certificates of deposit (CDs) will pay 0.25 or 0.50 percentage point more.
And inflation is not so high that cash is trash. Or, with individual bonds, as opposed to funds, you can hold to maturity and ignore fluctuating bond indexes.
Note: This item first appeared in Kiplinger Personal Finance Magazine, a monthly, trustworthy source of advice and guidance. Subscribe to help you make more money and keep more of the money you make here.
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