Bond Market Mayhem: History Says This Is the 1 Thing That Matters Most for Investors

The 10-year Treasury yield is up more than 100 basis points in 2026, including a 50-basis-point increase just since the beginning of September.

That's lifted long-term Treasury bond yields to levels not seen in nearly a quarter-century. As a result, the iShares 20+ Year Treasury Bond ETF (NASDAQ: TLT) is down another 8% year to date and still sits 45% below its 2020 high.

Even though it's easy to focus on the damage, here's what I think a lot of investors are missing right now. The yields that have created so many losses over the past few years are also creating opportunities for bond investors today.

Current Treasury yields are offering the highest income levels in two decades. And if the Iran war ends, inflation comes down, or the economy slows, those yields are very likely going to come down. This creates a near-term opportunity to capture 10%-plus share price gains on top of 5% yields.

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Why the bond market is so volatile

Several factors are pushing Treasury yields higher.

Rising oil prices get most of the blame, and rightfully so. Brent crude prices have soared since the start of the Iran war -- and at $110 a barrel, they're more than high enough to crush consumer demand if they stay there.

Even though oil prices have shown signs of peaking over the past month, the Bureau of Labor Statistics reported a 0.4% month-over-month increase in the overall inflation rate in August. Rising price pressures aren't nearly over.

While many are calling on the Fed to raise rates to combat inflation, it may not be the correct path. The core inflation rate, which excludes food and energy prices, is up a much more modest 2.4% year over year. That's still above the Fed's target, but not so much that it requires radical action.

Plus, a higher Fed funds rate may have a minimal impact on geopolitical price pressures. The energy problem is a supply-driven one. A Fed rate hike isn't going to do much to solve that until the oil starts flowing again.

All of that uncertainty is pushing long-term Treasury yields all over the place. The bond market is reacting to inflationary pressures, but soaring government debt levels are also playing a part.

The one thing that matters more than the Fed

Most investors right now are looking at recent bond market returns and want nothing to do with this asset class. But I see an opportunity that comes from investing in bonds with yields at multi-decade highs.

Imagine making an investment in the iShares Core U.S. Aggregate Bond ETF (NYSEMKT: AGG) back in the 2010s through roughly 2022. The yield on the fund during that time was roughly 2% to 3%. With a portfolio duration of roughly five to six years, that means yields only had to rise by roughly 50 basis points before the share price loss wiped out a full year's worth of income.

Today, the iShares Core U.S. Aggregate Bond ETF is yielding 5.1%. That means yields would need to rise by nearly 100 basis before you lost a year's worth of income. Plus, there's far more share price appreciation potential today than there was then. The high starting yield plus the possibility of a resolution to the Iran war means that investors could pocket a 5% yield while enjoying significant share price upside in addition to it.

Today's higher starting yield improve the risk/reward trade-off of bonds substantially.

Here's what I'd do with my portfolio today

Long-term investors probably don't want to make significant asset allocation changes to their portfolios. If you have 10-plus years left to invest, stocks are probably going to still provide the best return potential.

But I think there's enough of an opportunity here that bonds are worth at least considering. Even though yields could very well go higher here, they're offering a 20-plus-year income moment. And there's share price appreciation in a way we haven't seen in some time.

There's a case to be made for shifting a small portion of your portfolio over to bonds in order to improve risk/reward prospects. If you look toward the future instead of just the past, you can appreciate the investment case here.

David Dierking has positions in iShares Trust-iShares 20+ Year Treasury Bond ETF. The Motley Fool has positions in and recommends Vanguard Total Bond Market ETF. The Motley Fool has a disclosure policy.