- Vanguard says bonds are back, thanks to Fed policy tightening.
- Strategists at the asset manager said rising interest rates were a good thing for bond investors.
- “Rather than a scourge, rising interest rates represent the best development for bond investors in 20 years.”
After two years of negative total returns, bonds are back — and investors can thank the Federal Reserve, according to Vanguard.
“Short-term pain can lead to long-term gain,” Vanguard strategists said in a note released Wednesday.
Markets increasingly believe that the central bank has completed its historic cycle of rate hikes and that rate cuts are imminent. Vanguard, for its part, expects policy easing to begin in the second half of the year.
Regardless, higher interest payments offset lower bond prices and increased expected long-term total returns, according to the firm. Vanguard said reinvestments and new capital flowing into fixed income appear attractively valued.
“[C]”Central banks’ removal of their bond purchase programs could reduce liquidity and increase the risk premium (investors’ demand for a higher yield as compensation for the risk of changes in bond rates). (interest over the life of a bond),” they added.
Vanguard’s proprietary models suggest that Treasuries are close to fair value based on current fundamentals, which was not the case two years ago.
Based on the chart below, a hypothetical investor who placed a lump sum in a bond portfolio in 2021, similar to the Bloomberg US Aggregate Bond Index, for example, would have experienced sharp declines in 2022.
The model shows that the portfolio would break even in 2030 in a situation where interest rates remain low and bond prices do not fall.
However, investing new money would allow you to reach the break-even point much sooner.
“In contrast, bonds at the long end of the maturity spectrum may be somewhat undervalued,” the strategists argued. “In summary: rather than a scourge, rising interest rates are the best development for bond investors in 20 years.”
Recall that in October, Treasuries experienced one of the worst stock market crashes in history, and industry veterans of the time were saying that this presaged a recession in 2024 and 10-year yields exceeding 5 .5%.