Bond markets often appear counterintuitive. When interest rates rise, investors might expect fixed-income assets to become more attractive. Instead, bond prices typically fall, creating a period of volatility that can catch many by surprise.
The year 2022 provided a historic case study for this dynamic. As the Federal Reserve aggressively hiked the benchmark rate from near zero to over 4% in a single year, the bond market suffered its worst performance in modern history.
The relationship between yields and prices is mathematically inverse. A bond is a contract for a fixed stream of cash. If you own a bond paying 2% and the market suddenly offers new bonds at 5%, your 2% bond is objectively less valuable. To find a buyer, the price of your bond must drop until its yield matches the new 5% market standard.
We saw this play out with the iShares 20+ Year Treasury Bond ETF (TLT). As the 10-year Treasury yield climbed from around 1.5% at the start of 2022 to over 4% by late 2023, the price of TLT collapsed by roughly 45% from its pandemic highs.
Duration acts as the multiplier for this price movement.
Duration measures a bond’s sensitivity to interest rate changes. For every 1% rise in rates, a bond’s price falls by approximately 1% for every year of its duration.
In 2022, the Vanguard Total Bond Market ETF (BND), which has an average duration of about 6 years, fell by over 13%. This was a significant drawdown for an asset class usually prized for stability. Investors in long-dated debt, like the 30-year Treasury, faced even steeper losses because their duration was closer to 17 or 18 years.
The “Total Return” perspective is often lost in the noise of falling prices.
While rising rates cause immediate capital losses, they create a more productive environment for future income. In early 2022, a 10-year Treasury yielded a meager 1.5%. By 2024, investors could lock in yields above 4%.
For institutional giants like Apple or Microsoft, rising rates are a double-edged sword. While the cost of issuing new debt increases—Apple’s interest expenses rose noticeably in late 2022—these companies also hold massive cash piles. They can now reinvest that cash into short-term Treasuries yielding 5% instead of 0.1%, partially offsetting the higher cost of their long-term debt.
Real yields provide the necessary context.
Investors must distinguish between nominal yields and real yields (nominal yield minus inflation). In June 2022, U.S. inflation peaked at 9.1%. Even if a bond yielded 4%, the “real” return was deeply negative. It wasn’t until inflation cooled toward 3% in 2023 and 2024 that bond yields became “restrictive” and attractive on a real basis.
This shift is why capital began flowing back into fixed income. When the real yield on a safe Treasury note exceeds 2%, it becomes a formidable competitor to the riskier earnings yields of the S&P 500.
Credit spreads add another layer of complexity.
Corporate bonds, tracked by ETFs like the iShares iBoxx $ Investment Grade Corporate Bond ETF (LQD), react to both interest rates and economic health. If rates rise because the economy is booming, the risk of default drops. This can cause “credit spreads” to narrow, which cushions the blow of rising benchmark rates.
However, in a “stagflation” scenario—where rates rise while the economy weakens—corporate bonds suffer a double hit: falling prices from higher rates and widening spreads from increased default risk.
The yield curve reflects the market’s collective forecast.
Usually, long-term bonds yield more than short-term ones. But since mid-2022, the U.S. Treasury curve has been “inverted.” Short-term yields, like the 2-year Treasury, stayed higher than the 10-year Treasury.
This inversion happens when investors believe the Fed’s rate hikes will eventually cause a recession, forcing rates back down in the future. It is a signal that the market views current high rates as a temporary shock rather than a permanent plateau.
For the long-term investor, the primary lesson is that bond volatility is often a function of timing rather than permanent loss. If a bond is held to maturity, the interim price fluctuations do not change the final payout.
The risk in a rising rate environment is not the rate itself, but the speed of the change. Slow increases allow markets to adjust. Sudden, aggressive hikes—like the 75-basis-point moves seen in 2022—force a violent repricing that defines modern fixed-income cycles.
FAQ
Why did TLT fall so much more than BND in 2022? TLT holds long-term bonds with high duration (17+ years), making it much more sensitive to rate hikes than the diversified BND (6 years).
Can a company like Apple benefit from rising rates? Yes, if their cash reserves (earning higher interest) are larger than their immediate refinancing needs.
What does an inverted yield curve actually mean? It means the market expects a recession or lower inflation in the future, which would eventually lead to lower interest rates.
Is 5% a “good” yield for a bond? It depends on inflation. If inflation is 2%, a 5% yield is excellent. If inflation is 6%, that same 5% yield results in a loss of purchasing power.
What is the “Buy the Rumor, Sell the News” equivalent in bonds? Bonds often move before the Fed actually changes rates, as the market “prices in” expected future hikes.