Bond Outlook Q2 2022

Chris Keith

Senior Vice President, Fixed Income Manager

Q2 Bond Market Outlook

I won’t sugarcoat it—Q1 bond market performance was disappointing for most investors. Bonds are supposed to be the safety buffer in a portfolio, but they didn’t act that way to start the year. Instead, our portfolios got a flat tire during rush hour—making a frustrating experience even worse. They declined 5.9% and the Treasury bond index declined 5.6%. I can practically hear the heavy sigh as you wonder, “What’s wrong with my bonds?”

The short answer: Nothing. There was no major U.S. default shockwave or marketwide downgrade in credit quality. Rather, bond performance in the first quarter reflected investors’ response to the Federal Reserve switching into attack mode.

What happened? The Fed was lax when they should have been active, and inflation has hung around longer than expected and at a higher level. After digging in on the “transitory” inflation theme last year, the Fed is now on the move. It hiked the fed funds rate 0.25% in March, and it looks like this is just the beginning. I suspect the Fed believes inflation could pop a little higher in response to supply disruptions and other pressures resulting from the Russian war on Ukraine.

Bonds Hit a Pothole in Q1

For bond investors, rising interest rates are a double-edged sword. You’ve heard us state many times that higher interest rates will eventually produce more income from your bonds as new money or reinvested dividends and interest payments are put to work. But as yields rise, the bonds we already hold lose market value (not face value). While that’s disconcerting, you will eventually be compensated by higher rates.

All of this leads me to a difficult conclusion: Q2 will likely continue to be challenging for bond investors.

Having acknowledged this, let’s stick to the long-range plan. As bond investors, we’ve waited too long for interest rates to climb higher, and the last thing I’d recommend is giving up on bonds now that they have. At Adviser Investments, we know how bonds work, and we understand the value of reinvesting dividends and interest payments whether they are from bond funds or individually held positions. We have a plan for where and how to position your portfolios.

Spoiler alert: We will be exploring any and all opportunities and will continue to focus on higher-quality bonds.

Paraphrasing some of my past comments, we know that sentiment changes, and when it does, nothing says rates can’t reverse direction and head lower. After all, it’s not only other asset classes that get oversold. Bonds can be oversold, too.

We may have hit a pothole, but my expectation is that bonds will be less volatile than other asset classes and do the job of balancing risk in investor portfolios over the long term. In the meantime, we will continue to act in your best interests and be ready to roll once that flat tire is fixed.