Bonds: Say Hello to an Old Friend

It may be time to give bonds another chance

In times of uncertainty, the things we’ve always counted on become even more important to us. Bonds have been used as a steady standby in good investment portfolios to soften the surprises that stocks can bring.  

So, when investment markets responded to the inflation and interest rate rises in 2022 with stocks and bonds dropping together, our faith in bonds vanished. This could be the first time on record that all types of bond funds declined together in the same year. 

“Basically, it’s never been worse than the last year,” said Edward McQuarrie, a business professor emeritus who has compiled U.S. bond returns going back to 1794. 

2022 broke the mold 

Long-term bonds did not carry interest rates comparable to the fast-rising rates the Fed introduced in 2022, which were raised to combat extraordinary inflation. 

To explain, bond investors receive income when their bond (loan) makes an interest payment – at the agreed upon interest rate at the time of purchase – and when the bond ends, or matures with a final repayment of that loan. 

So, for example, if your bond paid you an interest rate of 3% over 30 years, it would lose market value when the current interest rate rises above that 3%. When a long-term bond keeps paying an inferior interest rate for 30 years, your loss is much greater. 

The rising interest rates of the last year have been terrible for long-term bonds, but great for short-term, fixed-income bonds and money markets. 

Expectations for 2023 

The expectation that bonds will be viable investment options in 2023 is based on some current positive signs. Right now, bonds provide much greater income than at the beginning of the year and over the next year, inflation is expected to fall and take interest rates with it. 

Prices of U.S. 30-year Treasuries have gained over 10% in the past month, while UK-based fixed income funds saw inflows of 1.09 billion pounds ($1.33 billion) in November, the highest in two years. 

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