next year for bonds

Despite a brief rally in December, the bond market suffered its worst decline in decades, thanks to rapid and large interest rate increases by the Federal Reserve in 2022. Bond prices and interest rates move in opposite directions: when prices go up, bond prices go down .

Finally, there was nowhere to hide, says John Lovitto, chief investment officer for global fixed income at American Century Investments. The broad bond index, the Bloomberg US Aggregate Bond Index, fell 11.6% over the 12 months ending in early December.

To make matters worse, stocks also faltered. People buy bonds in part to ease the stock market downturn, but last year, bonds didn’t fare much better than stocks. “It left a sour taste in their mouth,” says financial advisor Leo Altfest, of Altfest Personal Wealth Management.

Things often look their worst before they get better, however, these days most analysts agree that the bond market is at an inflection point. “Bonds will come back in 2023,” says Luis Alvarado, an investment strategy analyst in the global fixed income strategy team at the Wells Fargo Investment Institute.

The worst of the price hikes are probably behind us. Most analysts expect the Fed to raise short-term interest rates two times more, by smaller increments than in past months (0.50 percentage point or less), before pausing to assess the impact of the rate increases on inflation. From there, the Fed may hold off for a while longer, it may raise interest rates more if inflation does not subside enough, or it may lower rates if the economy falls hard into recession.

In any case, interest rates are higher now, and investors should hold on to yields while they can. For example, the 10-year Treasury yield recently yielded 3.55%, up from 1.75% a year earlier. Altfest says this means investors now have a cushion in interest income to offset any drop in bond prices, should interest rates rise.

In addition, investors do not have to take a lot of risk to earn a decent return. “They don’t have to buy long-term bonds or lower credit quality,” says Mary Ellen Stanek, chief investment officer at Baird Asset Management. In fact, a recurring theme for 2023, including iShares investment strategist Gargi Chaudhuri, is “Raising the bar with quality.”