Bond Market Volatility: Strategies for Investors Amid Rising Yields and Fiscal Uncertainty

There's been a lot of noise in the bond market lately, and with the 10-year treasury hitting its highest level since 2023 on Wednesday, what's giving investors pause isn't going away.

Between planned Treasury buybacks and the Federal Reserve's latest announcement signaling a possible rate hike that puts the agency at odds with President Donald Trump's desires, many bond owners are scratching their heads about what's next. This comes amid broader inflation concerns weighing on bondholders, a roughly $2 trillion federal deficit, and over $40 trillion in government debt that doesn't show signs of easing.

"Tuning out the noise is one of the hardest things for anyone to do," said Ian Toner, partner and head of investments in the institutional consulting practice at New York-based Cerity Partners. Nonetheless, he cautions investors who are considering moving money based on headlines to think hard about whether something has fundamentally changed in the economy or the market on a long-term basis or whether they're reacting to short-term news flow. "Most news is short-term, and most portfolios should be long-term. That intersection is emotionally hard, but really important to drive successful results," he said.

Financial advisors and investment strategists say there are plenty of options for investors to ride out bond market uncertainty rather than rush into potentially bad decisions.

Yields are higher across the curve, and despite Trump administration attempts to project calm, it can spook the markets. But for buy-and-hold investors, higher yields can be a good thing. "To me, that's a positive sign for future returns because the yields are now higher for the bond market, generally speaking," said Marta Norton, chief investment strategist at Denver-based Empower. "I do not agree that bonds are dead. They may not have the tailwinds that they had in past decades, but they still have a role for investors and portfolios," Norton said.

Don't run from bonds, diversify fixed-income maturities

As long as an investor has a diversified plan in the fixed-income space, most of the uncertainty will likely stabilize and become much clearer, Toner said. A diversified portfolio can include a broad market ETF such as the iShares Core U.S. Aggregate Bond ETF (AGG), a short-duration ETF, treasury inflation-protected securities (also known as TIPS), corporate debt and some floating-rate debt, strategists said.

To be sure, the AGG has suffered a massive drawdown, experiencing steep losses in the period since 2020 even with the bond coupon reinvested. That is because when the near-zero interest rate environment of the pandemic reversed, sending yields steadily higher, it punished bond prices. The AGG is also heavily concentrated in treasuries, at roughly 45%, which could continue to be a headwind. But with yields as high as they are now, the AGG does have what is known as a much greater "cushion" against price volatility in bonds than it did when rates were near zero.

Some high-profile figures in the market have warned that having any treasuries' duration exposure at all is a mistake, with the uncertainty related to government debt and Fed policy in the fight against inflation likely to keep pushing rates up at least in the short-term. More investors are turning toward ultra-short bond ETFs, which saw inflows of $12.8 billion in July, according to Morningstar Direct. These funds add slightly more yield than money market ETFs or mutual funds, with only a bit more risk, according to financial strategists. Another option within the short-term bond ETF universe is the PIMCO Low Duration Fund (PTLDX), which has a one- to three-year duration range and an adjusted expense ratio of 0.46%.

Consider corporate bond opportunities

Kratz said he's also been buying high-quality corporate debt, looking for opportunities in the 5% range and above. It's a "nice trade-off" for not much risk above Treasuries, he said. For preferred debt, he's looking for opportunities above 6%.

Ken Roban, partner and managing director at Reservoir Road Wealth Management at Steward Partners in Stamford, Connecticut, said he is buying shorter-term corporate bonds. He uses actively managed ETFs such as the Dimensional Short-Duration Fixed Income ETF (DFSD), which has a net expense ratio of 0.16% and held 1,593 bonds as of July 31. Roban also likes the Neuberger Berman Short Duration Income ETF (NBSD), which has net expenses of 0.35% and 1,104 holdings as of Aug. 31.

While he's sticking to short-term corporates at present, he said he's mulling over a switch to longer-term corporate bond strategies. "I'm waiting to see some hint of fiscal restraint from the U.S. government. It's something I'm watching really closely," he said.

Kratz is also looking at opportunities in short floating-rate debt that will reset if rates rise, so investors get paid more money for the bond. His focus is on high-quality issuers with senior debt that's A-rated or higher. The idea is this: to lock in around 5% for six months. If it resets in six months and doesn't mature or get called, he could get 6% on the new coupon. "For me, that's pretty attractive," he said.

Hedge for inflation with gold and TIPS

Roban is starting to buy TIPS for clients' retirement accounts, laddering them based on maturity between five and 15 years.

If inflation stays in the 3% to 4% range, it's a good deal, he said. You're getting a real return of around 2.4%, and when a TIPS matures, you get either the inflation-adjusted price or the original principal, whichever is greater. You never get less than the original principal.

Hedging in commodities including gold is another option. An investor who has concerns about fiscal policy and geopolitics might consider gold for 5% to 10% of the bond portion of the portfolio, Norton said. But be mindful that gold wasn't the hedge last year that people expected, so you should still go light on it. "There's an unpredictability to commodities," she said.

If you do sell bonds, don't go to cash

Jeff Mortimer, founder partner and chief investment officer of Elyxium Wealth in Beverly Hills, California, has been shifting money out of bonds for several months. His firm is looking at other income-oriented investments such as merger arbitrage ETFs and actively managed merger arb funds. Merger arbitrage takes advantage of the price gap between the announcement of a merger and its completion, offering returns uncorrelated with interest rate risk. The strategy produces a bond-like risk/return profile outside of the fixed-income market, according to Morningstar, which notes, "The upside is limited, akin to a bond's coupon, but the downside loss potential is significantly larger if the deal breaks."

"We believe that the long-term bond bull market has ended and that investment approaches should shift to reduce fixed income exposure, shorten duration, and diversify into other asset classes to manage risks from rising debt and interest rates. These asset classes may include commodities and liquid alternatives," Mortimer wrote in a recent LinkedIn post.

Some investors may be tempted to shift entirely away from bonds to cash, but McCarron advises against it since cash doesn't beat inflation. Instead, he takes a more balanced approach. "We want to have some duration in the portfolio for yield and for portfolio balance in case of an economic slowdown, but you don't want to be too long in terms of your position," he said.