Chart of the Week: Are Bonds Back?

Chris Keith

Senior Vice President, Fixed Income Manager

You’ve probably heard by now—2022 was the worst calendar year on record for bonds. But what you may not know is that the bond market recorded its second-best January of all time, kicking off 2023 with a 3.1% gain.

The strong start to the year restores confidence to bond investors who were understandably disappointed with how this “safe” asset class performed last year.

Right now, two questions come to mind when assessing recent performance:

1. Have we seen a market bottom for bonds?

We don’t make these kinds of calls at Adviser, but we like where we are right now. If in fact the bottom is in, then it occurred in late October 2022. Since then, bonds have returned 7.8%.

There’s more ground to make up, but just as bonds didn’t drop all at once, neither will they recover all at once.

Thanks to the higher yields born from last year’s sell-off, investors who reinvest interest, dividends and principal as bonds mature are benefiting not only from higher income, but also from prices trending higher. It was challenging at times last year, but we had a high degree of confidence that bonds would once again add value to investor portfolios. That has been the case over the last few months.

2. How is it that bond prices are rising if the Federal Reserve is still hiking?

Investors seem to believe the Fed will eventually need to reverse course on its interest-rate policy. Hence, they are pricing a lower fed funds rate into the markets now. When investors anticipate lower interest rates, and thus lower yields, prices rise on bonds. This theme is contributing to recent gains.

It is our belief that the Fed will get to a point where it stops hiking and then stand pat without cutting rates—the “higher for longer” mantra we hear some analysts embracing. The job of wrangling inflation down to acceptable levels has begun, but it’s not over. If the central bank acts in accordance with its messaging to date (and I have every reason to believe it will), we’ll see lower interest-rate policy once inflation is in check.

My takeaway: Bonds have been pulling their weight again over the last few months, delivering higher income and positive total returns. Investors who have locked in higher yields should benefit from that higher level of income even if prices turn lower unexpectedly.