asset allocation | february 8, 2021
The Challenge of Low but Rising Rates
Searching for yield amid rising rates.
With the 10-year U.S. Treasury yield increasing, government bond investors face the dilemma of low but rising interest rates.
High yield bonds are typically less sensitive to rising interest rates and may offer investors higher current income.
Tim Murray, CFA
Capital Markets Strategist, Multi‑Asset Division
The 10-year U.S. Treasury yield has been on a downward trend for the last decade, reaching a remarkable low of 0.50% on August 4, 2020. However, the yield has been steadily increasing since then. Going forward, government bond investors may be facing the worst of both worlds—the dilemma of low but rising interest rates.
For investors, low rates mean the current expected income from government bonds is limited, while rising rates mean the market value of their investment is decreasing. From an asset allocation perspective, this is particularly troublesome as bonds are important portfolio building blocks for two reasons—income and downside risk management.
To cope with this challenging dynamic, investors could consider increasing their allocation to higher-yielding corporate bonds. The right chart below compares the yield and duration (price sensitivity to rate changes) for both the Bloomberg Barclays U.S. Aggregate Bond Index and the Bloomberg Barclays U.S. High Yield Index. As illustrated, high yield bonds should offer higher income, currently, and are also less sensitive to rising rates.
Subscribe to T. Rowe Price Insights
Receive monthly retirement guidance, financial planning tips, and market updates straight to your inbox.
Searching for Yield Amid Rising Rates
High yield versus investment-grade bonds
Past performance is not a reliable indicator of future performance. Yields and duration are subject to change.
Sources: T. Rowe Price analysis using data from FactSet Research Systems Inc. All rights reserved. Bloomberg Barclays. See Additional Disclosures.
1Modified Duration to Worst: Duration to worst is a measure of the sensitivity of the price of a bond to a change in interest rates, assuming the worst-case scenario—in this case, that the bond is called at its earliest possible call date.
The primary downside to high yield bonds, however, is their higher credit or default risk, especially during times of economic stress, relative to investment-grade bonds. While this is a valid concern, the current environment appears favorable for credit risk for the same reason that interest rates are rising—i.e., improving economic growth expectations.
A low but rising interest rate environment can be challenging for bonds, but, fortunately, it may benefit higher-yielding bonds. For this reason, the T. Rowe Price Asset Allocation Committee favors high yield bonds over investment-grade bonds.
Financial data and analytics provider FactSet. Copyright 2021 FactSet. All Rights Reserved.
Bloomberg Index Services Limited. BLOOMBERG® is a trademark and service mark of Bloomberg Finance L.P. and its affiliates (collectively “Bloomberg”). BARCLAYS® is a trademark and service mark of Barclays Bank Plc (collectively with its affiliates, “Barclays”), used under license. Bloomberg or Bloomberg’s licensors, including Barclays, own all proprietary rights in the Bloomberg Barclays Indices. Neither Bloomberg nor Barclays approves or endorses this material, or guarantees the accuracy or completeness of any information herein, or makes any warranty, express or implied, as to the results to be obtained therefrom and, to the maximum extent allowed by law, neither shall have any liability or responsibility for injury or damages arising in connection therewith.
This material is provided for informational purposes only and is not intended to be investment advice or a recommendation to take any particular investment action.
The views contained herein are those of the authors as of February 2021 and are subject to change without notice; these views may differ from those of other T. Rowe Price associates.
This information is not intended to reflect a current or past recommendation concerning investments, investment strategies, or account types, advice of any kind, or a solicitation of an offer to buy or sell any securities or investment services. The opinions and commentary provided do not take into account the investment objectives or financial situation of any particular investor or class of investor. Please consider your own circumstances before making an investment decision.
Information contained herein is based upon sources we consider to be reliable; we do not, however, guarantee its accuracy.
Past performance is not a reliable indicator of future performance. All investments are subject to market risk, including the possible loss of principal. Fixed-income securities are subject to credit risk, liquidity risk, call risk, and interest-rate risk. As interest rates rise, bond prices generally fall. Investments in high-yield bonds involve greater risk of price volatility, illiquidity, and default than higher-rated debt securities. They involve higher risks than investment-grade bonds and government bonds. All charts and tables are shown for illustrative purposes only.
Get strategies and tips for today’s market conditions.
Contact a Financial Consultant at 1‐800‐401‐1819.