What 5% bond yields mean for your portfolio

For the first time in years, equities have serious competition from bonds. The US 10-year Treasury yield is now around 5.25% p.a¹., a level not seen since before the GFC, and the Australian 10-year Government bond yield is even higher².

We unpack why bond yields have risen, what that means for shares and how it changes the role of bonds in a portfolio.

When you buy a bond, you are lending money to a government or company for a set period. In return, you generally receive regular income and, assuming the issuer meets its obligations, the bond’s par value is repaid at maturity.

A bond yield is a measure of the return on offer from holding a bond.

Bond yields and prices move in opposite directions. When yields rise, existing bonds paying lower rates become less attractive, so their prices fall. When yields fall, existing bonds paying higher rates become more valuable, so their prices rise.

Government bond yields also act as an important reference point across financial markets. When a 10-year government bond is yielding around 5%, investors generally expect shares to offer enough additional return to compensate them for taking on more risk.

Several forces are pushing yields higher at the same time. “A combination of inflationary shocks, synchronised central bank hikes and a booming US economy has driven bond yields higher across the globe,” Betashares Senior Investment Strategist Cameron Gleeson says.

Inflation has picked up again. Australian inflation rose to 4.0% in the year to August, up from 3.5% in July, while trimmed mean inflation remained at 3.6%³. The RBA pointed to higher energy prices from the Middle East conflict, domestic capacity pressures and rising technology costs as reasons inflation remains elevated, reducing expectations for near-term rate cuts.

Building the infrastructure needed for AI requires enormous spending on data centres, chips, networking and electricity. PwC estimates capital spending will rise from around $800 billion in 2026 to $1.1 trillion in 2030⁴.

There is also more borrowing competing for investors’ money. Governments are issuing large amounts of debt, while technology companies are increasingly borrowing to fund their AI build-out. More bonds coming to market means borrowers may need to offer higher yields to attract buyers.

Government bonds set a near low risk bar for returns that shares need to overcome. With bonds at around 5%, that bar is higher.

Investors value shares by discounting expected future earnings back to today’s dollars, using a rate built on government bond yields, so when yields rise, those earnings are worth less today and share prices tend to fall. Higher borrowing costs can also squeeze company margins and household spending.

Global shares have had a strong year. For the 12 months to 30 September, the MSCI All Country World Index returned 11.2% in Australian dollar terms, compared with 2.7% for the S&P/ASX 200.

According to Gleeson, expected earnings for global companies have also grown faster than share prices. That’s pulled down the forward price-to-earnings (P/E) ratio, which compares what investors pay with what companies are expected to earn. Global shares are now about 16% cheaper on this measure than at the start of the year⁵.

Analysts have downgraded Australian company earnings since 30 June as they factor in higher rates and a weaker housing market. Despite the weak relative performance of the Australian market this has driven the price to earnings ratio higher. For every $1 of expected annual earnings, investors are paying about $17.40 for Australian shares, compared with about $16.20 for global shares⁶.

Yes, according to Gleeson. “Higher yields and solid equity returns can coexist when earnings deliver,” he says.

Interest rates were also higher before the GFC, and shares still performed well because company earnings grew fast enough to make up for it. Back then, investors paid between $13 and $17.20 for every $1 of expected earnings in global shares. At about $16.20 today, global shares sit inside that range.

The main risk is another jump in yields without earnings growth to match. “Earnings delivery, not valuation, is the thing to watch from here,” Gleeson says.

Global equities are expected to deliver earnings growth of around 16% in 2027. On that basis, he sees a stronger outlook for global shares than Australian shares for now.

Higher yields mean bonds are paying more income than they have in years. For income investors, government bonds above 5% now sit higher than the ASX 200’s dividend yield of 3.27%, or 4.27% with franking credits⁷, though compared to high quality bond coupons, dividends have less certainty.

Not all bonds respond to rising yields in the same way. Australian government bonds have the highest credit ratings in the Australian bond market. The AGVT Australian Government Bond ETF pays income monthly, and because it focuses on longer-dated bonds, maturing in seven to 12 years, it can provide meaningful upside if yields fall.

Fixed rate Australian corporate bonds like those held by the CRED Australian Investment Grade Corporate Bond ETF, offer more income than government bonds but carry credit and interest rate risk, and their prices can fall when market’s get more wary of corporations being able to repay their debts or when yields rise.

The value of floating-rate bonds, like those held by the QPON Australian Bank Senior Floating Rate Bond ETF, can be less sensitive to rising yields, as their income is not fixed, it adjusts as rates change.

Rising yields don’t mean swapping shares for bonds. But they do raise two things worth checking in your own portfolio.

With Australian earnings being downgraded and the extra return available from shares over government bonds now very thin, it may be worth reviewing how concentrated your equity exposure is in Australia.

At the same time, higher bond yields have made defensive assets more competitive. The key is whether your mix of growth and defensive investments still matches your goals and time horizon.