Rising Bond Yields: Strategic Approaches for Income Investors

Rising rates and bond market volatility are creating select opportunities for income investors. Treasury yields continued to climb on Thursday, with the benchmark 10-year yield reaching levels unseen since 2007 and the 30-year Treasury hitting highs not witnessed since 2004. Because bond yields move inversely to prices, the 10-year last yielded 5.179% while the 30-year reached 5.469%. This upward trend is driven by concerns over the federal debt and deficit, higher oil prices, persistent inflation, a robust economy, and the increasing likelihood of further Federal Reserve rate hikes. The central bank raised its benchmark rate by a quarter point last week, and the market currently prices in a roughly 70% probability of another hike at its October meeting, according to CME Group’s FedWatch tool.

Rebecca Venter, senior fixed income client portfolio manager at Vanguard, noted that the upward move in yields is justified by the strong economic backdrop. “An investor entering the market today for income is in a significantly better position than a year ago, given the much higher starting yield,” she explained. She added that this creates a more balanced outlook for future returns, allowing investors to earn more income on a steady-state basis and avoid rapid negative returns should rates continue to climb.

Investors should avoid excessive volatility in the bond market, particularly further out on the curve. Long-dated bonds possess greater duration, measuring their price sensitivity to interest rate changes. For those wishing to avoid significant interest rate risk, shorter duration instruments—typically up to about five years—are advisable. While Treasury bills are the safest option due to government backing, taking on slightly more credit risk with investment-grade corporates can provide a more substantial yield. This approach offers greater durability of return and yield compared to money market funds without exposing investors to excessive interest rate risk.

Michael Arone, chief investment strategist at State Street Investment Management, highlighted the attractiveness of short-term investment-grade corporates and floating-rate corporates in the one- to three-year space. Although these bonds have maturities of one to three years, their rates reset periodically. “Investors are shifting from fixed-rate coupons to floating rates that adjust as yields rise, offering increasing yields with minimal interest rate and credit risk,” Arone stated. For example, the State Street SPDR Bloomberg Investment Grade Floating Rate ETF (FLRN) boasts a 30-day SEC yield of 4.02% with a 0.15% expense ratio. Those willing to accept more credit risk might consider floating-rate bank loans, which fall below investment grade but offer yields exceeding 7%, providing adequate compensation for the risk taken.

Investors seeking additional income can move slightly longer into intermediate-term bonds, which are less volatile than longer-dated issues. Omar Aguilar, CEO and chief investment officer at Schwab Asset Management, identifies the five- to seven-year segment of the curve as the “sweet spot.” He favors investment-grade corporates, noting that corporate fundamentals remain very strong and balance sheets are still fairly solid across most sectors.

Leslie Falconio, head of taxable fixed income strategy at UBS Americas’ chief investment office, also favors the five- to seven-year curve for credit assets. However, she cautions against making concentrated investments all at once, as many recent yield jumps are knee-jerk reactions that tend to reverse quickly. “Strong growth and a hawkish Fed are now priced into the market; the risk is that the opposite occurs,” she warned. She recommends building positions incrementally over longer-term horizons—well above a decade—to compound high-quality income and establish a significant cushion against potential interest rate headwinds. Within credit, she favors investment-grade corporate bonds and agency mortgage-backed securities, while sticking with Treasurys and higher-quality high-yield corporate bonds on the shorter end.

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