US Bond Yields Surge to 20-Year Highs, Prompting Investment Shifts

Long-term US government bond yields have reached levels not seen in nearly two decades, with 10-year notes currently offering a 5.25% yield, having previously surpassed 5.3%. This surge has led to concerns about a potential market crisis, particularly given October's historically volatile market reputation. Zvi Stepek, founder of Meitav Investment House, notes that this trend is not unique to the US, with the UK at 5.4%, France at 4.9%, Germany at 3.5%, and Japan at 3.1% for their 10-year bonds. Israel has also seen rising yields, reaching 4.2% despite falling inflation.

Stepek highlights several factors contributing to the high yields. In the US, inflation is perceived as "sticky," and there are fears of further interest rate hikes by Federal Reserve Chairman Kevin Warsh, who appears less inclined to intervene in the market compared to his predecessors Bernanke and the former Fed Chairman. Even weak employment data has failed to significantly lower bond yields, suggesting a "sticky yield" phenomenon. High debt-to-GDP ratios, approaching 120% in the US and France, and over 200% in Japan, are significant concerns. Additionally, foreign investors, particularly from China and Japan, are reducing their holdings of US Treasuries, with foreign ownership dropping from 60% to 40%. This void is being filled by entities like hedge funds, which are more reactive to market movements. The cumulative US debt of approximately $40 trillion and the capital absorbed by major AI company IPOs are also pressuring the bond market.

While Israeli 10-year bonds currently yield 4.2%, lower than US bonds, Stepek notes this is a reversal of historical trends where Israeli bonds typically offered higher returns. The current US interest rate of 3.75% compared to Israel's 3.25% contributes to this shift. For Israelis seeking dollar exposure, a 5.25% yield on US bonds is attractive, a level last seen in 2007. However, the cost of hedging to shekels, around 2%, reduces the effective yield to approximately 3.25%, making Israeli government bonds more appealing at 4.22%.

Stepek advises a gradual approach to investing in US bonds due to uncertainty, suggesting investors buy in stages and adjust based on yield movements. For risk reduction, he recommends considering 5-year bonds. He also suggests potential benefits from a US bond investment during a market downturn: a fall in US stocks could weaken the shekel, leading to gains in dollar-denominated assets. This could result in a double benefit if stocks fall, or a solid 5% annual return if they don't.

Regarding the stock market, Stepek acknowledges the current rise seems counterintuitive given bond yields but notes that the S&P 500's stability masks declines in many individual stocks. He attributes this resilience partly to abundant capital and a psychological factor where younger investors seek higher, quicker returns through day trading, while experienced investors see value in the 5% annual bond yield, especially with lower long-term stock market return expectations. He also links it to the AI revolution, where investors anticipate dramatic profit increases across sectors, justifying higher stock multiples. Stepek suggests that investors holding a significant equity allocation might consider a slight reduction, rebalancing towards a range like 24%-25% from 29%, to mitigate potential risks if the US market experiences a downturn.