Anyone who’s been patiently waiting to step into new income investment is loving life right now. The recent rise in interest rates is not only pushing bond yields higher, but nudging yields on dividend stocks upward as well. Indeed, interest yields on super-safe 30-year Treasuries are now at a nineteen-year high of 5.35%, giving even the biggest fans of dividend stocks something else to consider.
There’s a downside to this dynamic for anyone who already owned bonds and other debt-based, fixed-income instruments, however. That is, to raise the effective yield on their fixed-income holdings, the market has effectively lowered the value of these bonds. For perspective, the average 30-year Treasury has lost about 5% of its market value over just the past year. That’s not a catastrophic setback for a stock. But, for bonds that usually don’t experience much price fluctuation, that’s a nerve-wracking degree of volatility. Some investors are bailing out in case things get worse. Other would-be bond buyers are waiting on the sidelines. There’s even an impact on stock prices themselves.
Here’s what you need to know.
Who’d want to jump on a sinking ship?
The toll that rising interest rates are taking on the bond market is clear. It’s not just U.S. Treasuries losing ground either. Corporate and municipal bonds are losing value too, as current owners jump ship while interest in newly issued debt is tepid.
And who could blame investors for being hesitant? Following last week’s decision to raise the baseline rate by this much, the market is betting on at least one more — and maybe even two more — quarter-point increases in the Fed Funds Rate this year. That will work against the value of bonds already in investors’ hands, pushing their interest rate yields higher to match the then-prevailing yields. As brokerage firm Charles Schwab‘s recent commentary on the matter plainly suggested, “now is not the time to favor long-duration [bond] investments.”
It’s not just bond investors looking to defend themselves from this dynamic, however. Even if only indirectly, stocks are being impacted too, for a couple of reasons.
How rising interest rates work against stocks
Plenty of investors insist on owning nothing but stocks regardless of the market environment. Simultaneously, a bunch of investors wouldn’t touch a stock with a 10-foot pole, sticking with bonds no matter how little they might be yielding.
There’s a sizable swath of people in between these two extremes, however, who will find the optimal, risk-adjusted opportunity at any given time. When interest rates were lingering at generational lows between 2009 and 2022, dividend-paying stocks were the go-to solution, even for income-minded investors. With long-term Treasury yields now markedly higher than most income-producing stocks’ dividend yields, however, investors have good reason to avoid those stocks and instead step into bonds. This crimped demand for income stocks of course works against their market value.
This volatile migration isn’t over yet, though. As was noted, at least one more rate hike is likely this year. Perhaps two. This will not only rattle bond prices, but rattle the value of dividend-paying stocks as their prices adjust with respect to income-generating alternatives. The crowd’s still trying to balance their relative risk and reward, now, and for the likely future (which they’re still trying to predict). It could take a while to figure out what these stocks’ prices should be here. There’s little doubt that the dynamic works against them though.
As for the other reason higher interest rates affect stocks, as intended, it crimps growth by making it more expensive for consumers as well as corporations to borrow money.
Image source: Getty Images.
Higher rates won’t likely have an immediate measurable impact on corporations. Companies that needed cash have already raised enough for a while at lower interest rates. It could be several quarters — if not a few years — before the need to reload the coffers rematerializes in earnest. It’s going to happen, though, and it’s going to cost considerably more than it has in a while.
Consumers will run into the headwind much sooner. In fact, they already are. Since bottoming in 2016, 90-day credit card delinquencies among U.S. borrowers reached a 15-year high at the end of last year, and have stayed near these levels ever since. Delinquencies on car loans are also at multiyear highs, perhaps at least partially fueled by the fact that the average payment on a new car (according to credit bureau Experian) currently stands at a stunning $765 per month, an equally stunning $542 per month for a used vehicle.
Connect the dots. Consumers’ spending power is clearly being worn down. Higher interest rates will only accelerate this grind, posing a threat to all companies, but a particular threat to companies that operate consumer-facing businesses.
Not disastrous, but nothing to shrug off either
It’s not a black and white matter, to be clear. There are still nuances that will allow companies to do well enough, just as there are still reasons to own dividend stocks rather than bonds even if bonds offer higher starting yields. Dividend growth is one of these reasons.
Ignore the dynamic and the likely — even if tempered — impact on stocks at your own peril, though. At the very least stocks will struggle to perform in the foreseeable future as well as they have in the recent past. You’ll want to pick and choose your holdings far more carefully now than you’ve needed to in a while.
