The year ahead for bonds

Despite a brief rally in December, the bond market has suffered its worst drop in decades thanks to a swift and significant rate hike by the Federal Reserve in 2022. Bond prices and interest rates move in opposite directions. When interest rates rise, bond prices fall.

After all, “there was nowhere to hide,” says John Lovito, co-chief investment officer of global fixed income at American Century Investments. The Bloomberg U.S. Aggregate Bond Index, a broad bond benchmark, fell a whopping 11.6% in the 12 months to early December.

To make matters worse, stock prices have plummeted. People buy bonds to cushion stock market falls, but bonds have been far less favorable than stocks in this past year. Lew Altfest, his financial adviser at Altfest Personal Wealth Management, said:

But things often look worst before they get better, and these days most analysts agree that the bond market is at an inflection point. “Fixes will come back in 2023,” said Luis Alvarado, an investment strategy analyst on the Wells Fargo Investment Institute’s Global Fixed Income Strategy team.

The worst rate hikes seem to be past. Most analysts expect the Federal Reserve to raise short-term interest rates several times in smaller increments (0.50% or less) than in previous months before assessing the impact of higher interest rates on inflation. From there, the Fed could pause longer, raise rates further if inflation hasn’t cooled enough, or cut rates if the economy slips into recession.

Either way, with interest rates rising now, investors need to secure yield while they can. For example, the recent yield on the 10-year Treasury bill was 3.55% for him, up from 1.75% for him a year earlier. According to Altfest, this means that investors have a cushion of interest income to offset falling bond prices should interest rates rise even slightly.

Moreover, investors do not have to take a lot of risk to get a decent yield. Mary Ellen Stanek, co-chief investment officer at Baird Asset Management, said: “They don’t need to buy long-term bonds or undermine their credit quality. The recurring theme for 2023 will be “improving quality.”