Bond Market Crash: What It Is and How to Prepare

The bond market comprises corporate and government debt. A rapid decline in bond prices signals a bond market crash. Bonds play a significant role in the global economy. The bond market was about 25% bigger than the equity market in 2022^[0]

Interest rates and the price of bonds have an inverse relationship. As interest rates go up, the market value (price) of bonds declines. When the Federal Reserve raises the federal funds rate, it can cause the bond market to crash. This happens because new bonds offer higher interest rates than previously issued bonds, and that pushes the prices of older bonds down in the secondary market. For bondholders, this is known as interest rate risk. Rising interest rates in 2022 triggered the Treasury bond market crash that played a significant role in the collapse and sell-off of Silicon Valley Bank in early 2023.

However, if you hold a high-quality bond for its entire duration, you should still receive your initial investment back upon maturity. Interest rate risk most significantly affects bondholders who sell bonds before maturity, especially bonds of longer duration.

That’s unclear. Lindsey Young, a certified financial planner based in Baltimore, Maryland, reminds us that the last couple of years have been unusually bad for bonds.

“2022 was actually the worst bond market in the last hundred years,” says Young. “Bonds also performed relatively poorly during the first nine months of 2023 before rallying at the end of the year.”

Even though further interest rate hikes remain unlikely, the continued high interest rate environment wasn’t good news for bondholders. In January 2024, the Fed communicated its intent to focus on reduced inflation before bringing rates down. Lowering the federal funds rate is factor that would alleviate the downward pressure on bond prices.

Bonds are generally considered a less-risky complement to the volatility of stocks in an investment portfolio. U.S. Treasurys, and specifically Treasury bills and Treasury notes, are the benchmark for a nearly risk-free investment if held to maturity. As a result, people often look to the 10-year Treasury yield as a barometer of the economy.

But that doesn’t mean that investing in Treasurys or bonds doesn’t come with risks — such as interest rate risk — especially if you plan to sell before the bond’s maturity. That’s because bonds are still highly affected by interest rates and the broader economy.

Economic shocks are temporary and often unavoidable. Regardless, spreading your investment dollars across different types of investments by diversifying can help reduce the risks associated with any one asset. Owning different types of bonds and bonds of varying durations can also help reduce exposure to interest rate risk.

Buying many bonds bundled together in bond funds is one strategy for quickly and inexpensively diversifying your bond portfolio. For example, short-term bond funds are less likely to be affected by interest rate risk because interest rates typically increase or decrease slowly over months and years. In bonds with shorter durations, there’s simply less time for interest rate risk to take hold.

It’s hard (or impossible) to predict a crash. But you can prepare your mindset for how to respond when it happens. Try to avoid selling when the market is down if you can. Remember, when you sell, you lock in your losses. A bond market crash won’t last forever, and you don’t want to lose out when the market rebounds.

Bond crashes can significantly impact investors close to their money goal, such as someone approaching retirement. One financial strategy is to hold a portion of the money you need short-term in investments less likely to be affected by interest rate risk, such as money market funds, high-interest savings accounts, CDs and short-term bond funds.