Bond Market Review & Outlook Q4 2021

Chris Keith

Senior Vice President, Fixed Income Manager

The U.S. bondA financial instrument representing an IOU from the borrower to the lender. Bond issuers promise to pay bond holders a given amount of interest for a pre-determined amount of time until the loan is repaid in full (otherwise known as the maturity date). Bonds can have a fixed or floating interest rate. Fixed-rate bonds pay out a pre-determined amount of interest each year, while floating-rate bonds can pay higher or lower interest each year depending on prevailing market interest rates. market was positive for investors in the third quarter—but just barely. The returned 0.05% while the Treasury bond index was up 0.08%. If the quarter ended in the middle of September, we’d be talking about much better returns, but that’s not the way it works.

What happened? Taper talk from the Federal Reserve and negative headlines surrounding the creditworthiness of Evergrande, the China-based real estate conglomerate, triggered the sudden price movement. But sensational news aside, the biggest story of Q3 was the continued advance of inflation at both headline and core levels and bond investors who seem undaunted by it.

The Fed has said inflation will be transitory…but how long does “transitory” last? The answer may be a point of conjecture among Fed officials, but I like how Raphael Bostic, president of the Federal Reserve Bank of Atlanta, summed it up: “Temporary is going to be a little longer than we expected.”

No matter what unfolds or how long it takes, I’m still investing in bonds. After all, even if I earn 1.0%, it’s a lot more rewarding than sitting in cash at 0.01%.

My Q4 outlook factors in the reduction of asset purchases (tapering) from the Fed, which could begin as early as this year and wrap up by mid-2022. Tapering may be followed by interest-rate hikes, but there is no guarantee this will occur anytime soon.

How bond investors will react as the Fed steps back is anyone’s guess, but I’ll take a shot. After an initial sell-off puts downward pressure on prices and yieldsYield is a measure of the income on an investment in relation to the price. There are several ways to measure yield. The current yield of a security is the income over the past year (either dividends or coupon payments) divided by the current price. rise, buyers will return in Q4 and beyond, spurred on by fears that the economy will weaken once government stimulus measures wane. Investors will then look for the safety, balance and lower volatilityA measure of how large the changes in an asset’s price are. The more volatile an asset, the more likely that its price will experience sharp rises and steep drops over time. The more volatile an asset is, the riskier it is to invest in. provided by bonds.

In other words, don’t give up on bonds! With volatility on the rise, a high-quality diversified bond portfolio still tends to offer more ballast than stocksA financial instrument giving the holder a proportion of the ownership and earnings of a company..

What’s more, I’ll welcome modestly higher yields—because yields have been too low for too long. Savers and fixed-income investors have been stymied under the weight of Fed policies, and I look forward to putting new dollars to work in the higher-rate environment while it lasts.