By Randall W. Forsyth
If bond yields are in a secular, multidecade uptrend, as seems likely, investors face two knotty problems. Higher yields translate into lower prices for bonds, which is bad enough. And if the reason for those rising yields is inflation, bonds won't provide much cushion for riskier assets, notably stocks.
But that doesn't mean eschewing fixed-income investing altogether. By taking a shorter-term tack, investors can experience the upside of the secular bond bear market: the ability to reinvest interest and principal cash flows at progressively higher yields.
Bond yields will be pushed inexorably higher by the "fiscal incontinence" of the U.S. government, as the ever-understated Albert Edwards, Société Générale's global strategist, wrote in a recent client note.
Federal budget deficits, running at 6% of U.S. gross domestic product, will result in "fiscal dominance" as the Federal Reserve bends policies to the Treasury's massive borrowing needs. That will produce inflationary "monetary debasement, which will be the expedient alternative to attempting to cut spending in a serious manner and arousing voters' ire," he concluded.
Deficit scolds' warnings of a bond market ruction have been like waiting for Godot, some economists say. But John Silvia, the former chief economist at Wells Fargo, writes in his Dynamic Economic Strategy note that the dam in Johnstown, Pa., held -- until it didn't in 1889. Similarly, he questions if the supply of credit will always be sufficient to absorb the rising tide of U.S. debt.
A major factor in that possibility has been Washington's interest cost, which has swollen to over $1 trillion annually. That's even though the average interest rate on the $39 trillion accumulated public debt has held relatively steady for the past two years, according to Stephanie Pomboy's latest MacroMavens missive. The government's interest tab had topped defense expenditures -- until the Trump administration's new budget called for a massive 40% hike to $1.5 trillion for fiscal 2027.
At the same time, America's foreign creditors are having to ramp up their own wartime spending, leaving less to lend to Uncle Sam, she adds. While foreign central banks were buyers in February, according to the latest Treasury International Capital data, the purchases were all short-term Treasury bills. That doesn't help to fund intermediate- and long-term borrowings.
The Fed itself also won't be helping to support the long end of the bond market, if Kevin Warsh, the nominee named to succeed Jerome Powell as the central bank's head, brings about what he has called "regime change." Warsh wants to shrink the Fed's balance sheet, mainly by shedding its holdings of $3.6 trillion of Treasury notes and bonds and $2 trillion of agency mortgage-backed securities.
A more steeply sloped yield curve would be the result, says George Goncalves, head of U.S. macro strategy at MUFG Securities America. That means intermediate- and long-term yields would be higher relative to short-term interest rates.
That leaves investors grappling with what to do in the likely rising-yield environment. Jim Kochan, who previously headed fixed-income strategy at Merrill Lynch and Wells Fargo, has actually experienced that kind of bond market.
In short, he says, stay short. Current income from coupon interest becomes more valuable as yields rise, he adds. Those cash flows can be reinvested at higher yields. One of the saving graces of the great bond bear market of the 1970s was that maturing bonds with low- to mid-single digit coupons were reinvested in new issues with coupons climbing into the double digits. If yields rise in the years ahead, a holder of today's 3.875% two-year Treasury may be rolling over that note at 5% in 2028.
In the municipal market, Kochan says to look to short- to intermediate-term bonds with ratings of single-A or double-A, but avoid long maturities with top triple-A ratings, which offer less value. For taxable bonds, he suggests intermediate corporates that are callable, which could mean getting more cash returned sooner to reinvest. Taxable munis, a sometimes overlooked sector, also provide good income from single-A-rated issues.
Treasury inflation-protected securities, or TIPS, should provide shelter from rising prices. But Kochan says to avoid TIPS until inflation adjustments to their principal takes place. Until then, TIPS are equally vulnerable to price risk as nominal Treasuries.
Funds generally are the way individuals invest in fixed-income these days. Kochan says to look for funds that specialize in credit research that add return without taking lots of duration risk. Most of the popular bond exchange-traded funds simply track an index and try to deliver the lowest possible expenses.
An exception is the JPMorgan Limited Duration Bond ETF, which is a top pick by Morningstar. The ETF steers clear of Treasuries, which comprise 70% of the Bloomberg 1-3 year US Government/Credit Index, opting instead for non-agency MBS, commercial MBS, asset-backed securities, and collateralized loan obligations. Over 72% of its portfolio carries a top triple-A rating, with relatively low expense ratio of 0.24%.
The legendary Peter Lynch once quipped that buying a government bond fund is like paying to hear Yo-Yo Ma on the radio. That was before their expenses were cut practically to nil. Among them, the Schwab Short-Term U.S. Treasury ETF costs just 0.03% annually, an expense matched the Vanguard Short-Term Corporate Bond Index ETF.
Shorter-term muni funds usually don't provide better after-tax yields, except for investors in the top tax brackets. For most residents of high-tax states, short-term Treasuries are tough to beat, since they're exempt from state and local taxes. A two-year T-note yields 3.8% -- more even after taxes than a top-grade two-year muni yielding just 2.29%
The BondBloxx IR+M Tax-Aware Short Duration ETF toggles between short-term taxable and tax-free issues to seek a better after-tax return. Its website shows a 3.12% 30-day Securities and Exchange Commission yield, which it says is equivalent to a taxable-equivalent yield of 5.06% from a portfolio that is 73.56% in munis.
One last tax-exempt choice is the BlackRock Municipal 2030 Target Term closed-end fund. Its current distribution yield is an unremarkable 2.42% but its price on Thursday of $22.94 was a 7% discount from its net asset value of $24.67. The fund is set to return $25 to shareholders on liquidation on Dec. 31, 2030, which would give an extra fillip of return.
Write to Randall W. Forsyth at randall.forsyth@barrons.com
This content was created by Barron's, which is operated by Dow Jones & Co. Barron's is published independently from Dow Jones Newswires and The Wall Street Journal.
(END) Dow Jones Newswires
April 24, 2026 16:05 ET (20:05 GMT)
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