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Early 2022 was bad for bonds but led to an attractive entry point for investors

The extent of the Q1 drawdown in fixed income markets was both large and rare relative to history. The aftermath of the pandemic and the conflict in Ukraine propelled inflation in developed markets around the world to multi-decade highs. In response, many central banks across developed markets have started to tighten monetary policy as they take steps to tackle rampant inflation. This triggered bonds to decline, for instance, the Bloomberg Global Aggregate Index fell by 6.2% in the first quarter. This was one of the bond market’s worst quarters in the past 30 years — the 2.6-standard deviation move would be the equivalent of stocks declining 16% in a quarter — but it also led to a cheapening in valuations which may prove compelling.¹

A significant number of Fed hikes are already priced in

While the Fed’s current hiking cycle likely has more rate increases to come, current bond prices already anticipate that move. At this point, the market has priced in a significant number of short-term rate increases in the coming quarters and longer dated US Treasury yields (e.g. 10-year) already reflect that. In fact, forward rates suggest relatively limited moves on longer dated yields in the next year, which should lessen the negative impact on bonds.

Income opportunity in bonds is the brightest in years

Yields across fixed income sectors are sharply higher than their lows over the past few years. Going forward, investors now have the potential to earn significantly more income from bonds. In fact, a greater portion of investors’ income needs could potentially be met with traditional fixed income than would have been the case in recent years. Higher income can offer more cushion for total returns over time, even if price movements remain volatile.

Yields at current levels have historically delivered attractive returns

Starting yields in fixed income have historically been a good proxy for forward returns. Today’s higher yields suggest higher returns going forward. For example, in periods over the past few decades when yields were at levels similar to those in late May, bond returns were strong across the five-year periods that followed.

1. Data as at 31/03/22. Source: Bloomberg

 

Risk factors you should consider before investing:

• This material is not intended to provide investment advice or be considered a personal recommendation.
• The value of investments and income from them can go down as well as up and you may lose some or all of your
  initial investment.
• Past results are not a guide to future results.
• If the currency in which you invest strengthens against the currency in which the underlying investments of the fund are made, the value of your investment will decrease. Currency hedging seeks to limit this, but there is no guarantee that hedging will be totally successful.
• Depending on the strategy, risks may be associated with investing in fixed income, emerging markets and/or high-yield securities; emerging markets are volatile and may suffer from liquidity problems.