Bond, stock movements push, pull as rates rise

WNEW YORK ELL, that escalated quickly. After rising steadily for much of the past year, Treasury yields got a shot of adrenaline this week, and the yield on the 10-year Treasury leaped to its highest level in seven years.

U.S. Treasurys often act as the benchmark against which other investments are measured, and the surge in yields reverberated in markets around the world, prompting selling in both stocks and bonds.

Why are interest rates rising?

The U.S. economy is doing well, and the Federal Reserve is raising shortterm rates in response. Last week, the Fed raised its benchmark rate for the third time this year, and the federal funds rate sits at a range of 2 percent to 2.25 percent. It had been anchored at nearly zero for seven years after the 2008 financial crisis.

The Fed has less control over longer-term interest rates, which move mostly on expectations for future economic growth and inflation. Reports this week showing strength in the job market and services industry pushed up those expectations, and investors sold longer-term bonds accordingly. When a bond’s price falls, its yield rises, and the 30-year Treasury yield touched its highest level in four years.

What do rising rates mean for stocks?

Higher rates generally hurt stock prices for a few reasons. One is that higher rates make it more expensive to borrow, which can put pressure on corporate profits and tap the brakes on economic growth. Another is that higher yields make bonds more attractive investments, which can siphon buyers away from stocks.

With bonds paying meager interest, investors had gravitated toward stocks with the highest dividend yields. Now, those income-seeking investors have incentive to move back into bonds.

But a push-pull effect is also taking place. Rates are rising because of a stronger economy, which should help corporate profits. That’s giving some support to stocks.

What do rising rates mean for bond investments?

Bonds getting issued today are paying investors more handsomely than those issued a year ago. That’s good news for savers and investors looking for more income.

But those bonds issued a year ago look less attractive in comparison. That means their resale price drops, something mutual funds must account for. Prices for long-term bonds are more sensitive to rises in rates than short-term ones because they lock investors into a lower rate for a longer period.

As a result, bond funds have logged losses the past couple days.

Should I panic about rising rates?

Not if the rise happens gradually.

For bond funds, higher rates are knocking down prices, but they should also mean more income. If rates rise slowly, that higher income could offset the price drops and leave investors with positive returns.