Bonds are back – five reasons to invest now

We are amidst a great reset for fixed-income assets.  During 2022, bond prices moved lower and yields meaningfully higher, in the sharpest repricing in recent history.  Fixed-income markets now provide attractive yields not seen since before the 2008 Financial Crisis.

Inflation and rising interest rates are the nemesis of bond investors and last year proved a case in point.  Interest rates were hiked aggressively to counter the significant rise in inflation which caused bonds to sell off sharply. The stage is set for strong performance going forward and – despite global headwinds – we believe five reasons make investing in fixed-income assets attractive now. 

Inflation has peaked

Monetary policy operates with a lag.  It can take 12-18 months for interest rate hikes to be felt in the real economy.  The Federal Reserve announced its first rate hike in March 2022 followed by a further 10 hikes in rapid succession, the fastest tightening since the early 1980s. We are now seeing early signs of aggregate demand slowing.  Automobile prices, freight rates, housing rents, consumer savings, and PMIs all point towards inflation moderating.

These developments suggest that the Fed is reaching the end of its hike cycle and is close to achieving terminal interest rates.  The Fed has a long-term inflation target of 2% – a level that is intended to be low enough to reassure consumers but sufficiently relaxed to allow the economy to grow.  We believe that it is unlikely that the Fed will change its official targets.  However, the Fed will be conscious of the risk that tightening conditions too much could cause the slowdown to turn into a recession.  That is why we believe that it will back off if it is successful in bringing inflation down towards 3-4%.

Attractive all-in yields and income

Bond yields have risen sharply to levels not seen since 2008.  Bonds have discounted the rise in central bank interest rates with yields ranging from 3.7% for pan-European corporates to 9.5% for Emerging Market high yield corporates.

Starting yields are a good proxy for long-term total returns.  Despite the many market-moving events over the past two decades, they have ended up in a tight range around the entry points.  That is why we believe that today’s starting yields are attractive.

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