Bumpy Bonds, and Why Predicting Rates Is a Fool’s Errand

It’s been a rough stretch for bonds. Long Treasury yields hit levels we haven’t seen in almost twenty years, with the 30-year briefly touching 5.3%, and total federal debt crossed $40 trillion for the first time. Inflation, deficits, geopolitics, an uncertain rate path, there’s no shortage of things for investors to worry about.

The past few weeks made that case for us better than we could have written it ourselves. In mid-August, the U.S. Treasury caught markets off guard by announcing it would at least double the size of its long-term buybacks, from a $2 billion to $4 billion, aimed at the 10 to 30-year part of the curve where the selling had been ugliest. Yields dropped hard on the news. Then U.S. Fed Chair Kevin Warsh got up at Jackson Hole and struck a hawkish tone on inflation, and short and mid-term yields shot back up as traders started pricing in a real chance of a hike instead of the cut a lot of people had been expecting. In just two weeks, we went from the Treasury trying to hold long yields down to the Fed chair signaling he’s still willing to push them higher.

Then the U.S. Federal Reserve followed through. On September 16th it raised the federal funds rate a quarter point to 3.75-4%, the first hike since 2023, and the vote was unanimous. Most of the rationale pointed to inflation running hot again, primarily on energy prices tied to the Iran war, and left the door open to another hike before year-end. Stocks dropped on the news, then clawed most of it back. The interesting part isn’t the hike itself, it’s how we got there. Weeks earlier, plenty of people were still calling for a cut. The bond market had already dragged long yields to multi-decade highs on its own, doing a chunk of the Fed’s work for it before the Fed ever moved. This wasn’t really a new decision on the Fed’s part, so much as them catching up to where the market had already pushed things. Hard to find a cleaner case for treating rate calls as a fool’s errand.

All this turbulence is a big part of why we like investment-grade bond ladders.

First, what is a bond ladder? The idea itself is simple: instead of parking a large sum of money in one bond with one maturity, we spread it across multiple bonds coming due at different points over several years. Each year a slice matures and we receive that money back, which gives us flexibility no matter what rates end up doing.

If rates are higher when a bond comes due, that money gets reinvested at a better yield. If they’re lower, we’re still holding the longer bonds bought when yields were better. If rates are chopping around with no real direction, we keep collecting income and get a year closer to our principal back. The goal is never to predict the next move in interest rates, but rather to build a portfolio that can work across different rate environments without having to get a prediction correct.

Bond ladders sound simple enough, but they do require a bit of change in conventional thinking when you’re looking at statements or watching accounts regularly. The main thing that trips people up with bonds is staring at the daily price and forgetting how they actually work. A bond has a maturity date. If you buy a high-quality bond and hold it to that date, you will get your money back along with interest along the way. But bond prices bump around along the way also. When interest rates go up, bond prices go down. When rates go down, bond prices go up. This creates unrealized gains or losses in your investment account which can create the feeling that the strategy is or is not working in the short term. However, if you’re not selling the bonds before their maturity date, none of these price changes have any impact on what you’re actually going to end up with. The bonds keep paying interest and, assuming the issuer stays solvent, returns thier face value at maturity. That’s a completely different animal from an investment whose value depends on finding a buyer willing to pay up for it later.

That doesn’t mean you can throw darts at what you’re buying. Quality is a critical part of this strategy. On the defensive side of a portfolio, confidence that we’ll get our money back counts for more than squeezing out an extra sliver of yield. This is why we stick to investment-grade government and corporate names that we have high conviction in. There are always bonds paying more out there, and usually there’s a reason for it. At today’s rates, you can get real income from high-quality bonds without reaching into credit risk that was almost unavoidable when rates were near zero. That’s a real shift from a few years ago.

That said, knowing what we own is just part of the equation. We also want to know when the money is actually going to be needed. If there are cash needs coming over the next few years, we can structure the maturities around them. Money that won’t be touched for a while goes farther out. When a bond matures, we decide then: spend it, hold it, or reinvest it further out. We’re not forced to sell bonds at a bad time to raise cash. The cash we need has been planned for and is already heading our way on schedule.

That’s really what this strategy comes down to. We don’t know where rates are headed, but often we know when we’re going to need our money. We also like having some latitude in how we respond as bonds mature, regardless of what the markets are doing. The other thing we know is that high-quality bonds are paying well above what people got used to during the near-zero years. So, the question for us isn’t whether there is a perfect entry point. It’s whether we can build a portfolio that holds up across several different rate scenarios, because we’re not interested in guessing our way there.

If you’d like to talk through the bond market, bond ladders, or revisit your cross-border investment strategy, please reach out to request a consultation.