Under the pressure of the Federal Reserve’s campaign to raise short-term interest rates, U.S. domestic bond funds performed admirably in 2005. The average high-quality bond fund edged up 1.3%, while the average government securities fund gained a similar 1.4%.*
Perhaps tied to this surprising performance, flows into bond funds improved this year, despite the cloudy environment. According to the Investment Company Institute, taxable bond funds received $27.0 billion in net new cash year-to-date through the end of November, versus an inflow of $1.2 billion for the year-ago period.
Going forward, much depends on where the Fed takes interest rates in 2006. The Fed Funds rate currently stands at 4.25%, after 13 consecutive increases since June 2004. Bond investors are obviously hoping that stabilizing oil prices and modest core inflation might compel the central bank to slow down or end rate hikes.