Bond Market Outlook Q2 2021

Bond Market Review & Outlook Q4 2021

October 14, 2021
by Chris Keith, Senior Vice President, Fixed Income Manager
wdt_ID Bonds in 2021: Snapshot
1 • Despite ups and downs, interest rates are higher in 2021 compared to year-end 2020
2 • If you’re looking for the fed funds rate to rise, you’ll need to wait a little longer
3 • The real inflation question is, how long is “transitory”?
4 • Sitting in cash isn’t a better option than owning bonds

The U.S. bond 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%.

Bond Outlook 2021
Source: BLS, Bloomberg, Adviser Investments.

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 yields 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 volatility 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 stocks.

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.

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