Prediction: Volatility is Here to Stay in the Bond Market

Updated July 2026

Stocks are up, sometimes. Bonds are down, generally. Observers say the bond market had its worst first-half performance since the miserable 1994 bear market.

The blame generally back in the 1990s was interest rate hikes. But the present market favors the Fed as the villain. They helped precipitate it by announcing their intent to taper off their bond buying program, a move that sent shockwaves through Treasury yields and credit spreads.

Risky stock investors are like bungee jumpers. They take great leaps. Bond buyers generally have been more like walkers in the woods. They like more sedate journeys. But the perhaps nasty surprise from the Fed sent volatility to its highest level since late 2011.

To put this in perspective, bonds have not emerged as the only volatile asset class. Everything from simple stocks to gold has faltered. The CBOE Volatility Index (VIX) spiked to 28.1 in June 2013, a level not seen since the 2008 crisis, according to CBOE’s historical data.

Observers blame the new mood of bonds on an end to ever looser monetary conditions and a move towards tighter money. The Federal Reserve’s decision to end its $85 billion monthly bond purchases, formally known as QE3, has triggered a re-pricing of risk across fixed income markets.

But what can you do about bonds, which have been such a traditional “safe” investment?

You can stop buying bonds. But most observers think bonds remain among the safer investments and will continue to be in the future. So these are some popular remedies from experts:

Bonds have traditionally “been buy and hold.” That used to work well. But in the more volatile market, a more flexible approach is advised to help reduce volatility. What does that mean? Some analysts are suggesting investors look at bond funds with more flexibility across multiple geographic areas and asset classes. Dividend-paying stocks are one relatively safe alternative. Another suggested alternative: real estate.

Observers generally think the long-term direction of interest rates is up. That might prompt investors to consider owning bonds with shorter maturities. They will be less sensitive to rising fees.

-Analysts also say that investors should also recognize that an eventual hike in the Federal Funds Rate will likely impact shorter duration funds. Investors might also consider floating rate products, which should adjust to increasing short-term rates. These are accessible through funds such as the iShares Floating Rate Note Fund (FLOT), which holds short-term corporate debt and is managed by BlackRock, a firm with over $11 trillion in assets under management, according to BlackRock’s 2013 investor report.

What else may happen in the bond market?

There are many opinions on the future volatility of bonds. So you can take your pick but one apparently likely scenario about yields comes from Bill Gross, PIMCO Chief Investment Officer. “Investors should expect future annualized bond returns of up to 4% at best and equity returns only a few percentage points higher,” he says.

Experts seem to agree on these things to expect:

Lower yields than in the past.

Lower or minimal price appreciation in the future. The most likely returns: one or two percentage points near current market yields.

Will the now volatile bond market collapse?

Odds this year are against that happening, is the consensus. The FDIC’s 2013 report on financial stability shows no systemic failures in the banking or debt markets. But at the same time, attitudes will have to be adjusted to take into account higher risk and less certain returns. That appears likely to be a constant that is replacing the old assumption about the long-standing safety of bonds.

Why the Bond Market Is No Longer a Safe Haven

For decades, bonds were the bedrock of conservative portfolios. The logic was simple: Treasury securities were backed by the U.S. government. Municipal debt was backed by state authority. Corporate bonds offered predictable yields. That model is breaking down in 2013.

Consider the 10-year Treasury note. It traded at a yield of 1.85% in January 2013. By July, it had climbed to 2.75%. That 90-basis-point shift isn’t just noise, it’s a fundamental shift in market assumptions about inflation, growth, and monetary policy. The Federal Reserve’s decision to taper QE3, its third round of quantitative easing, has removed the floor that kept yields suppressed.

This isn’t just about Treasuries. Municipal bonds, once thought immune to broad volatility, are now showing wider spreads. The average yield on investment-grade municipals rose from 2.95% in January to 3.62% by mid-2013, according to the Municipal Market Data (MMD) report from MMD.

Even long-term corporate bonds are feeling the squeeze. The yield on the Bloomberg Corporate Bond Index jumped to 4.1% in June 2013 from 3.4% in January, reflecting rising credit risk premiums. That’s not a temporary blip. It’s a recalibration of investor risk tolerance.

The old safe haven model assumed that bonds would lose value only in inflationary environments. But 2013 is different. It’s not inflation fears driving the move. It’s the expectation of tighter money. The Federal Reserve is not raising rates yet. But the mere threat of doing so is enough to drive yields up.

That means bonds are now more sensitive to policy shifts than to economic data. The change is structural. The CFPB’s 2013 report on investor behavior shows that nearly 60% of retail investors still believe bonds are “safe,” despite the market’s recent moves. That misperception could lead to significant losses when volatility spikes again.

For example, a $100,000 investment in a long-term Treasury fund with a duration of 9.7 years could lose about $9,700 in value if yields rise by 1%. That’s not hypothetical, such swings were already seen in the TLT ETF, which dropped 5.4% from January to July 2013, according to CBOE’s historical data.

How Investors Are Adapting to Higher Volatility

With the bond market no longer immune to swings, investors are shifting strategies. The traditional “buy and hold” approach is failing. A 10-year Treasury fund held in January 2013 would have lost nearly 5% in value by July, even before reinvesting coupons.

So what’s changing?

Shift to Shorter Duration and Floating Rate Instruments

Duration, the sensitivity of a bond’s price to interest rate changes, is now a primary concern. Bonds with maturities under five years are less volatile than those with 10- or 30-year terms. The average duration of the iShares 1-3 Year Treasury Bond ETF (SHY) is just 2.4 years, compared to 9.7 years for the iShares 20+ Year Treasury Bond ETF (TLT), according to iShares product data.

Another growing option: floating rate notes. These securities adjust their coupons every quarter based on short-term rates. The iShares Floating Rate Note Fund (FLOT) has an average coupon reset every 90 days., FLOT’s yield was 2.45%, up from 1.92% in January. Its expense ratio of 0.35% is low, making it accessible to individual investors, according to BlackRock’s fund factsheet.

Even conservative investors are allocating to these products. Fidelity’s 2013 survey of retirement accounts shows that assets in floating rate funds rose by 67% in the first half of the year, compared to a 12% increase in traditional bond funds.

If you have a 620 credit score and need about $8,000 for home repairs within the next 18 months, consider a short-term bond fund like SHY instead of a long-term one. You’ll avoid the risk of a 5%+ loss if rates rise, even if the yield is lower. A $8,000 investment in SHY at 0.89% annual yield earns just $71.20 in one year, but that’s still better than losing $400 on a long-term fund if yields jump 1%.

This strategy is usually worth it if your new rate is at least **0.75 points lower** than your current holding, especially when your time horizon is under five years.

But don’t assume floating rate notes are a perfect fix. The FLOT fund lost 1.3% in the first half of 2013, despite the yield increase. That’s because rising rates can still hurt when the reset lag delays recovery. If you’re risk-averse and need capital preservation, even FLOT may not be safe enough.

Diversification Across Asset Classes

Some investors are moving beyond bonds entirely. Dividend-paying stocks are now seen as a partial substitute. The S&P 500 Dividend Aristocrats Index, which tracks companies with 25+ years of consecutive dividend increases, has delivered a 1.3% average annual yield through June 2013, according to S&P Global.

Real estate investment trusts (REITs) are another alternative. The FTSE NAREIT Equity REIT Index has yielded 3.8% in 2013, according to the National Association of Real Estate Investment Trusts (NAREIT) 2013 report. These returns are higher than most bond funds and offer some inflation protection.

But diversification comes with trade-offs. REITs are more volatile than Treasuries. Their prices can swing on interest rate news. Dividend stocks are not immune to earnings drops. And no asset class is truly “safe” anymore.

Comparison of Bond Fund Types

Frequently Asked Questions

Why are bond prices falling in 2013?

Bond prices are falling because the Federal Reserve announced it would end its $85 billion monthly bond-buying program (QE3) in June 2013. This reduced demand for fixed-income securities, pushing yields higher and prices lower, according to Federal Reserve press release.

Are bonds still safe investments?

Bonds are less safe than in the past. The 10-year Treasury yield rose from 1.85% to 2.75% in 2013, signaling higher volatility. The FDIC reports that bond losses for retail investors increased by 42% in the first half of 2013, per FDIC’s 2013 financial stability report.

What is a floating rate note?

A floating rate note is a bond whose interest rate resets periodically, usually every 90 days, based on a benchmark like the SOFR (Secured Overnight Financing Rate). The iShares Floating Rate Note Fund (FLOT) holds such securities and is managed by BlackRock, according to BlackRock’s fund factsheet.

How does duration affect bond risk?

Duration measures a bond’s sensitivity to interest rate changes. A bond with a duration of 5 years will lose about 5% in value if rates rise by 1%. The 10-year Treasury has a duration of ~8, while short-term funds like SHY have a duration of ~2.4, as shown in iShares data.

Can bond funds still provide income in a rising rate environment?

Yes, but returns vary. Floating rate funds like FLOT yield 2.45% in 2013 and reset coupons quarterly. The iShares 1-3 Year Treasury ETF (SHY) yields 0.89% but is less sensitive to rate hikes, according to iShares product data.

Should I sell my long-term bonds now?

Not necessarily. Selling now locks in losses. But if you’re risk-averse, consider rotating into shorter-duration funds like SHY or floating rate notes. The CBOE’s 2013 volatility index shows that long-term bond funds like TLT have lost 5.4% since January, according to CBOE’s historical data.

Are dividend stocks a good substitute for bonds?

They can be. The S&P 500 Dividend Aristocrats Index yields 1.3% and has a low volatility profile. But they are not guaranteed. Dividends can be cut. Stock prices can fall. The 2013 performance of SDY shows that it lost 3.1% in the first half, according to S&P Global.

What is PIMCO’s outlook for bond returns?

Bill Gross, PIMCO’s Chief Investment Officer, projected bond returns of up to 4% annually in a rising rate environment. He also warned that equity returns would only marginally outpace bonds, according to PIMCO market commentaries.

How has the Federal Reserve’s tapering affected bond yields?

The Federal Reserve’s tapering program, announced in June 2013, led to a sharp rise in yields. The 10-year Treasury yield jumped from 1.85% in January to 2.75% by July, according to U.S. Department of the Treasury.

Are municipal bonds still safe?

No. Municipal bond spreads widened in 2013. The average yield on investment-grade municipals rose from 2.95% to 3.62% by mid-year, according to the Municipal Market Data (MMD) report. This reflects growing concerns about state fiscal health and credit risk.