Bond Market Outlook Q1 2021

Bond Market Outlook 2021

Bonds in 2021: A Snapshot

wdt_ID Bonds in 2021: Snapshot
1 ·      Interest rates head higher in 2021
2 ·      The economy regains its footing, inflation rises but remains non-threatening to recovery
3 ·      Treasurys, as always, will be the bonds most sensitive to interest rate moves
4 ·      A slower than expected economic recovery would mean Treasury yields have more room to fall, and falling yields mean higher prices and returns
5 ·      Bonds continue to be low risk, not no risk, and do their job for investors

2020 in Review

Mitigating risk in a low interest-rate environment has never felt so satisfying. The bond market rewarded investors with a respectable 7.51% return in 2020, nearly matching 2019’s 8.71% return, and ultimately living up to its reputation as the investment we rely upon to help balance risk in our portfolios.

That’s not to say the year lacked volatility: Even higher quality investment-grade bonds suffered during a few gut-wrenching weeks in March. In a classic flight-to-safety move, investors scrambled to buy Treasurys and the yield on the 10-year benchmark bond fell to 0.54% as investors sought refuge from the pandemic’s economic impact. (Remember, when prices rise, yields fall.)

The turning point for bonds arrived in late March, when Federal Reserve policymakers announced their intention to use whatever tools they could to support households, businesses and the economy. It was a case of words speaking louder than actions—and markets turned on a dime for the better.

In early August, the benchmark Treasury yield sank again, closing at an all-time low of 0.52%. Subsequently, yields have marched higher, ending the year at 0.93% and crossing above 1.00% early in 2021.

Our Outlook

Virtually all investment and economic outlooks for 2021 are predicated on moving past the pandemic. Recovery will truly begin when several safe and effective vaccines are in full distribution, something we expect to be the case by the end of the first or early in the second quarter. This should lead to a full reopening of schools, a return to the workplace and a surge in domestic and international travel.

What’s good for economic growth isn’t always a net positive for bonds, and we expect a tougher environment for bond investors this year: As the economy recovers and expands, interest rates may rise further, hurting bond prices. However, this will also lead to higher yields on every dollar invested or reinvested in the bond market. This higher income will begin to offset lower prices and eventually be a win for those who maintain, rather than reduce, their exposure to the bond market.After years of no-to-low inflation, we expect it to rise, along with yields, in 2021. The Federal Reserve has targeted 2.0% inflation, and we think we’ll surpass that level sometime during the year (if only briefly). Runaway inflation is not in the cards from our vantage point, though.

Treasurys are the most sensitive bonds to interest-rate moves because they are considered “risk-free” from a credit perspective. By contrast, corporate bonds, with their higher yields, may better withstand an initial move higher in interest rates as investors assess their value based on other factors. We continue to favor corporate and municipal bonds in our portfolios while underweighting Treasurys. With the possibility of higher income-tax rates this year or next, municipal bonds will find greater appeal in the months to come.

Notwithstanding the above-average price gains earned over the past couple of years, the coupon return (income produced by bonds) has historically been the bigger driver of bond investors’ returns. In 2021, that income will be important as the long, 40-plus-year bond bull market may end its charge. Investors should be prepared to earn their yields, or slightly better, as the economy and inflation pick up speed.

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For informational purposes only; not a recommendation to buy, hold or sell any investment product. Past performance is not an indication of future returns. All investments carry risk of loss and there is no guarantee that investment objectives will be achieved. Speak with a financial adviser before taking specific action. The investment ideas and opinions contained herein should not be viewed as recommendations or personal investment advice or considered an offer to buy or sell specific securities. Data and statistics contained in this report are obtained from what we believe to be reliable sources; however, their accuracy, completeness or reliability cannot be guaranteed.

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