Why it’s important to understand bond rates [Financial Perspectives]

If you have been watching the news in the last few days, you may have seen that the yield on the 10-year U.S. Treasury Bond has risen to 2.1 percent.  It is up almost .50 percent since the beginning of May. This may not seem like a big deal, but the impact of this is significant for several reasons. 

First, it is a sign that the economy is improving. It is typical for bond yields to rise when the economy is improving. It’s clear that some folks have reduced their bond allocations and move some of their money into stocks.  The challenge, however, is that rising bond yields mean that the value of bonds are  falling.

The price drop is more dramatic for bonds with longer maturities. This is a problem if you need to sell bonds in your portfolio to cover spending needs.

Second, mortgage rates are tied to the 10-year Treasury Bond yield.  As yields on bonds move up, so do mortgage rates. Rates on the 30-year fixed mortgage have moved above 4 percent, which is about .50 percent more than they were several weeks ago. Rates are still in the very low end of the historical range, but eventually, higher rates will have a detrimental effect on home prices. This normally occurs when the economy is peaking and is headed toward a recession.

Third and finally, rising bond yields have already prompted the Federal Reserve Chairman, Ben Bernanke, to say that the Fed will slow down its Treasury bond purchasing program. Many economists have argued that this is needed because this program is going to result in a huge inflation problem in the not too distant future.

It has also eroded the value of the dollar.  The erosion of the dollar can make goods appear more expensive. More importantly, it may have triggered a currency war with the other major economies of the world.  The potential implications of this are numerous and complex.

The action steps coming out of these changes in the bond market depend on how you are affected.

If you are in the midst of buying a home, it would make a lot of sense to lock in your mortgage rate as soon as you can. Rates do fluctuate every day, but when you see such a big change in a few weeks, it is quite possible that rates will continue to climb.  If you are an investor, whether you have personal investments or retirement funds (401k, IRA, Roth IRA, 403b, etc.), you may want to take a look at the bonds in your portfolio.

If you are holding bonds in your portfolio you may want to look at the maturities of the bonds.  If you are holding bonds (either bond funds or individual bonds) with maturities more than five years, you may want to evaluate these bonds for potential changes.  If you are holding individual bonds and you will not have to use these funds until the bonds mature, you do NOT need to go through this exercise. If you do not feel comfortable going through this exercise, I would highly encourage you to seek help from a qualified professional.

Good luck with your planning!

The views expressed are not necessarily those of Cambridge and should not be construed as an offer to buy or sell any security.

Jim Heisler, CFP®, CDFA™, CASL™ Family Wealth Services, LLC 8725 Frankford Avenue Philadelphia, PA 19136 jim@familywealthservices.net 215-332-4968

Jim Heisler is a Certified Financial Planner with Family Wealth Services in Holmesburg. You can read all his Financial Perspective columns here.