Beaten-up bond market may be nearing ‘escape velocity. ‘ Here’s what that means

Beaten-up bond market may be nearing 'escape velocity. ' Here's what that means. Two terms in the fixed-income market are wise to keep in mind: "price cushion" and "escape velocity.

What happened

"After a relentless rise in rates after 2020, bond investors have more cushion as prices fall, meaning the prospect for losses is much lower, and "escape velocity" can be reached, a dynamic in which fixed income can deliver positive overall returns even if rates continue to rise. "Even though the rise in bond yields so far this year has been orderly, and it has not happened overnight, these elevated yields could be here to stay for some time, especially with geopolitical concerns and elevated energy prices continuing to remain front and center," Carol Schleif, chief market strategist of BMO Wealth Management, wrote in a recent commentary.

But you won't get nearly the same losses we saw in 2022 and 2023, because the starting point is so much better," said Cullen Roche, founder of San Diego-based Discipline Funds, who coined the term "escape velocity" to illustrate how and when bonds can deliver positive returns even if rates rise. Where investors who have soured on bonds are searching for incomeHow to play the metals trade as Trump's trade war turns to CanadaThe best way to invest in the S&P 500 in 2026 isn't the core indexDon't sell the large-cap stock market, but do build around it.

Rising yields across the bond market have spooked investors, but the surge from zero interest rates since Covid suggests fixed-income risk-reward has improved. Skip NavigationMarketsBusinessInvestingTechPolitics & PolicyVideoWatchlistInvesting ClubPROLivestreamMenuKey PointsWith 10-year treasury yields breaching the 5% market and reaching their highest level since 2007 on Tuesday, bond investors are thinking more seriously about whether this is an opportunistic moment. Many investors have focused on short-or ultra-short-term bonds lately to sidestep bond market volatility that has pummeled prices as rates rise due to concerns over broader economic issues like inflation and the federal deficit.

The wider picture

However, there's a silver lining for bond investors, especially with rates expected to be elevated for an extended time. Certainly, more risk-averse investors can buy a money market fund with an attractive yield and take duration off the table, and there is always an opportunity cost in making investment decisions when seeking income, with some investors still preferring stocks that generate attractive yields. 10-year Treasury yield hitting 5%Squawk on the StreetNevertheless, concerns about bond prices are still elevated and are likely to remain high, and investors can seek a zone within the fixed-income market that opportunistically targets yield while acknowledging the rise in interest rates isn't over.

Here are a few basic factors that investors eyeing opportunities in bonds should be thinking about now. Roche developed a tool to identify the point on the government bond yield curve where the bond yield equals its modified duration. 84% increase in yields before the mark-to-market loss on that bond wipes out one year of interest income, said Michael Reynolds, vice president of investment strategy at Philadelphia-based Glenmede. This means that investors might start to consider bonds with slightly longer maturities — say five-to-10 years.

There is still a lot of interest in one-to-three-month bonds, where investors can get 3.

What has been reported

Several ETF options can give investors exposure to the bond market. For broader bond market exposures, the Vanguard Total Bond Market ETF (BND) is an intermediate-term bond fund with more than 11,000 bonds and an average coupon of 3. Both of these broad bond market funds hold close to half of their portfolios in treasuries. The 5% threshold on the 10-year Treasury makes bonds more compelling, and if it stays there for three to six months, more investors will take notice, she said.

It's especially compelling, she said, if you think inflation can stay at 2% to 3% over 10 years. watch nowVIDEO4:1504:15Dan Niles: We're going into a rate hike cycle so don't fight the Fed or the bond marketSquawk on the StreetChoose CNBC as your preferred source on Google and never miss a moment from the most trusted name in business news. But as yields rise, the risk-reward calculation for medium-term bonds — those in the 5-to-10-year range — is becoming more favorable for investors.

Market-watchers widely expect the Federal Reserve to boost the target federal funds rate by one-quarter of a percentage point on Wednesday amid rising oil prices and the ongoing war with Iran. "As yields have gotten higher, there's much more cushion than there was in 2020," said Alec Lucas, director of fixed income for manager research at Morningstar.

What happens next

Many bond strategists believe that higher yields will remain for a prolonged period. How the bond 'price cushion' works and why it mattersBond prices have an inverse relationship with yields, so as yields rise, prices drop. The bond breaks free from rate risk over the same period in which it earns its coupon. With rates where they are today, "anything five years and lower, you have a cushion. ETF Strategist full coverage:Here's a look at other stories offering insight on ETFs for investors.

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