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September 29, 2022 at 02:24 PM
What You Need to Know
- Bond investors face a tricky path in the current environment, and volatility in bond prices is expected to persist over the short to medium term.
- Investors have a chance to lock in rates of 5% or higher on high-quality intermediate term bonds, Schwab's Kathy Jones says.
- The Fed's projections point to lower rates in 2024 and 2025, Jones says.
With the U.S., the U.K., Norway, South Africa, Switzerland and Sweden all raising interest rates in the last week, the global markets have now seen more than 300 individual rate hikes in little more than a year.
In bond market commentary shared with ThinkAdvisor, Hal Cook, a senior investment analyst with Hargreaves Lansdown, points out that these rate rises have caused significant capital falls in the value of bonds so far in 2022. In turn, bond investors have witnessed the first meaningful rise in yields seen for many years, with 10-year government bonds in the U.S. climbing past 1.5% at the beginning of the year to now stand near 4%.
Cook says the consensus now is that rates will peak at 4.6% next year, based on the Federal Reserve dot plots. This is pushing bond fund managers to be cautious while they seek to position their funds for longer-term return generation.
“This is a tricky path to walk in the current environment and volatility in bond prices is expected over the short to medium-term,” Cook says.
What’s an Investor to Do?
Asked to put this outlook in context for financial advisors and their clients, Kathy Jones, chief fixed income strategist at the Schwab Center for Financial research, says the current environment presents a lot of challenges, but also a lot of opportunities.
“The inverted yield curve has historically been a signal of recession in the next 12 months or so,” Jones says. “Often, investors don’t see a reason to extend duration into intermediate or long-term bonds when short-term yields are so high.”
The problem with that strategy, Jones says, is that the market is signaling that yields will most likely fall over the next year or two. As such, if the Fed continues on its aggressive rate-hiking path, long-term yields will likely lag short-term rates by a larger margin, due to the prospects for weak growth and falling inflation in the longer term.
“Our view is that it makes sense for clients who have been holding money in cash or short duration bonds to start taking on more duration as rates rise,” Jones says. “Although yields are lower on intermediate- to long-term bonds than cash, locking in those yields today is an opportunity.”
