Bonds and especially those characterized as high investment grade remain the preferred choice for Trust Economics. With yields trading at multi-year highs – a result of interest rate hikes by central banks – government bonds offer returns far better than any deposit account (even term deposits) while missing the risk of equity investments and commodities.
The yield on the 2-year U.S. Treasury note has climbed to a 17-year high of 5.2%, up 140 basis points from last May. The US ten-year yield has soared to a 16-year high of around 4.5%.
But with yields at such high levels is it a smart move to get into bonds? It is recalled that the following particularity applies to bonds: as yields increase, their prices fall, and on the contrary, when prices move upwards, yields follow the opposite course.
With central banks having signaled that one of the fastest rate-hiking cycles is coming to a close, bond yields are unlikely to move higher than today’s levels.
With the hypothetical scenario for central banks to make the first rate cuts sometime in mid-2024 or a bit earlier, the cost of funding in a broader context will start to get cheaper.
After peak yields what’s next?
So for bond yields after their peak during 2023, their path looks like a one-way street: they will start to decline.
In this case, if an investor has placed in bonds with high yields, it means that he bought them at lower prices. So when yields take a downward turn, their prices will rise, bringing profits to those investors who had planned to buy debt securities at low prices.
Positive signs of decelerating inflation, as well as signs of a slowdown in the US economy in 2024, are likely to act as a deterrent to US Federal Reserve policymakers.
Historically, the yield on the 10-year U.S. Treasury note peaks a few months after the Fed’s last rate hike, which could come at the Federal Open Market Committee meetings in November or December.
There are clear signs that central banks are at or nearing the end of their own rate hike cycle. The Bank of England did not raise interest rates on, Thursday September 22, as did the European Central Bank and the Swiss National Bank. Central banks in Brazil and Poland have started to cut interest rates and these moves have driven bond yields lower.
Over the next five years bond returns to investors will range between 15% and 25%, depending on currency and credit quality.
Investors who are wary should remember that simultaneous full-year losses in U.S. bonds and stocks in 2022 have occurred only three times since 1926. In a bearish scenario, Trust Economics thinks the 10-year Treasury could to rise 21% if stocks sink 17%.
