The peak in rate hikes is an inflection point for bonds
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The peak in rate hikes is an inflection point for bonds

You don’t have to be bearish on the economy to be optimistic on the bond market. Here’s why

As we head into 2024 we think that the next phase for the US Federal Reserve is likely a pause while the central bank assesses the impact of the tighter lending and financial conditions it has established. Investors should expect a lot of talk about whether the Fed will achieve a soft landing, but bond investors have a unique opportunity to generate attractive returns either way. Here’s our rationale:

Bonds have performed well around Fed pauses

Typically, Fed pauses like this last less than a year, and it doesn’t take a cut in rates for bonds to rally. History suggests that when the Fed reaches the peak of its rate hike cycle, overall bond performance in the period afterwards is exceptional (Figure 1).

Figure 1: bond returns after Fed rate hike peaks1

(Average forward return after a pause, %)

Figure 1 - bond returns after Fed rate hike peaks
Source: Columbia Threadneedle Investments

We’re not in the hard landing camp, but given the unknown magnitude of an economic slowdown and the level of inflation, we think that where investors are on the quality spectrum will make a difference. While lower-rated bonds have been strong performers in 2023, we think the market is going to be more discerning as we head into 2024. We expect higher quality bonds will be the best bond performers over the next year.

We also think performance will be more dispersed than it has been. As we enter a higher-for-longer rate environment we should see more separation between the winners and the losers – especially in lower-quality segments of the market. This will make credit selection more important, which is one of our core strengths.

Investors can lock in higher rates for the long term

Bond yields have risen to levels we haven’t seen in decades. We think investors shouldn’t miss the opportunity to lock in higher yields for the long term – not to mention the total return potential as prices on those bonds rise. It is also a great incentive to move out of cash. There has been a money market renaissance as investors realised they can own cash and get a competitive yield. The attractiveness of cash will start to fade when short-term interest rates move lower and the diversification benefits of owning high-quality, long-term bonds at higher yields start to make more sense.

Looking outside the US, opportunities may be even more striking in Europe, despite lower absolute yields. Unlike the US, Europe is coming off not just near-zero interest rates, but negative rates. Now, we’re not only seeing positive real interest rates but also wider credit spreads. That means you’re going to get more risk premium for a similarly rated bond in Europe than you would in the US. 

There’s more than one way to take advantage

There are two ways to invest in the bond market in 2024 that we think are equally valid, depending on how you feel about the economy:

1 Get paid with higher-yielding credit

If you feel growth will remain resilient (Stable growth in Figure 2) and are comfortable with the risk, the income from high yield bonds and bank loans can be a good addition to a diversified portfolio.

Figure 2: economic and inflationary outcomes 

Figure 2: economic and inflationary outcomes
12 months from now… Economy
Stable growth Recession
Inflation Lower
  • Fed pauses and then begins gradually cutting rates to neutral
  • Credit outperforms duration
  • Fed responds by cutting rates quickly and aggressively
  • Duration outperforms credit
Credit-orientated assets (eg high-yield, corporate bonds, non-Agency mortgagebacked securities) High quality durationsensitive assets (eg Treasuries, Munis, Agency mortgagebacked securities)
Higher
  • Fed resumes tightening to address persistent inflation
  • Credit and duration both underperforms
  • Fed’s ability to ease is limited by high inflation
  • High quality credit outperforms duration
Minimise duration (eg Bank loans) Credit-sensitive assets/moderate duration (eg short-term bonds)
Figure 2 - economic and inflationary outcomes

2 Seek income and protection with high-quality bonds.

If you’re not as confident about the economic outlook (Recession in Figure 2), you can take advantage of high-quality, duration-sensitive assets like Treasuries or municipals. These can be higher-quality assets that may help to protect from loss if we do have a harder landing.

We believe the peak in rates is near and a Fed pause will be a significant market event.

Bottom line

Our optimism for bonds is balanced by a realistic view of a still uncertain economy, but we think a hard landing is unlikely. More importantly, we believe the peak in rates is near and a Fed pause will be a significant market event. It’s an inflection point that has historically delivered outsized returns for bond holders. Combined with the opportunity to lock in attractive yields, we think now is an opportune time for investors to participate in the bond market.

23 November 2023
Gene Tannuzzo
Gene Tannuzzo
Global Head of Fixed Income
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The peak in rate hikes is an inflection point for bonds
1Represents data from 1984 to 2023. Three-month bills are represented by the Bloomberg US Treasury Bellwethers 3 Month Index, which is an unmanaged index representing the on-the-run (most recently auctioned) US Treasury bill with 3 months’ maturity; 10-Year Treasuries bonds are represented by The Bloomberg US Treasury Bellwethers 10 Yr. Index, an unmanaged index representing the on-the-run (most recently auctioned) US Treasury bond with 10 years’ maturity; Investment Grade is represented by the Bloomberg US Corporate Investment Grade Index, which measures the investment-grade, taxable corporate bond market; High Yield is represented by the Bloomberg US High Yield Corporate Bond Index, which represents the universe of fixed-rate, non-investment grade debt; Mortgage-backed securities are represented by the Bloomberg US Mortgage-Backed Securities Index, which tracks agency mortgage-backed pass-through securities. Municipals are represented by the Bloomberg Municipal Bond Index, which represents the broad municipal market. Past performance is not a guarantee of future results. It is not possible to invest directly in an index.
There are risks associated with fixed-income investments, including credit risk, interest rate risk, and prepayment and extension risk. In general, bond prices rise when interest rates fall and vice versa. This effect is usually more pronounced for longer term securities.

Important Information

For use by professional clients and/or equivalent investor types in your jurisdiction (not to be used with or passed on to retail clients). For marketing purposes.

 

This document is intended for informational purposes only and should not be considered representative of any particular investment. This should not be considered an offer or solicitation to buy or sell any securities or other financial instruments, or to provide investment advice or services. Investing involves risk including the risk of loss of principal. Your capital is at risk. Market risk may affect a single issuer, sector of the economy, industry or the market as a whole. The value of investments is not guaranteed, and therefore an investor may not get back the amount invested. International investing involves certain risks and volatility due to potential political, economic or currency fluctuations and different financial and accounting standards. The securities included herein are for illustrative purposes only, subject to change and should not be construed as a recommendation to buy or sell. Securities discussed may or may not prove profitable. The views expressed are as of the date given, may change as market or other conditions change and may differ from views expressed by other Columbia Threadneedle Investments (Columbia Threadneedle) associates or affiliates. Actual investments or investment decisions made by Columbia Threadneedle and its affiliates, whether for its own account or on behalf of clients, may not necessarily reflect the views expressed. This information is not intended to provide investment advice and does not take into consideration individual investor circumstances. Investment decisions should always be made based on an investor’s specific financial needs, objectives, goals, time horizon and risk tolerance. Asset classes described may not be suitable for all investors. Past performance does not guarantee future results, and no forecast should be considered a guarantee either. Information and opinions provided by third parties have been obtained from sources believed to be reliable, but accuracy and completeness cannot be guaranteed. This document and its contents have not been reviewed by any regulatory authority.

 

In Australia: Issued by Threadneedle Investments Singapore (Pte.) Limited [“TIS”], ARBN 600 027 414. TIS is exempt from the requirement to hold an Australian financial services licence under the Corporations Act 2001 (Cth) and relies on Class Order 03/1102 in respect of the financial services it provides to wholesale clients in Australia. This document should only be distributed in Australia to “wholesale clients” as defined in Section 761G of the Corporations Act. TIS is regulated in Singapore (Registration number: 201101559W) by the Monetary Authority of Singapore under the Securities and Futures Act (Chapter 289), which differ from Australian laws.

 

In Singapore: Issued by Threadneedle Investments Singapore (Pte.) Limited, 3 Killiney Road, #07-07, Winsland House 1, Singapore 239519, which is regulated in Singapore by the Monetary Authority of Singapore under the Securities and Futures Act (Chapter 289). Registration number: 201101559W. This advertisement has not been reviewed by the Monetary Authority of Singapore.

 

In Hong Kong: Issued by Threadneedle Portfolio Services Hong Kong Limited 天利投資管理香港有限公司. Unit 3004, Two Exchange Square, 8 Connaught Place, Hong Kong, which is licensed by the Securities and Futures Commission (“SFC”) to conduct Type 1 regulated activities (CE:AQA779). Registered in Hong Kong under the Companies Ordinance (Chapter 622), No. 1173058.

 

In Japan: Issued by Columbia Threadneedle Investments Japan Co., Ltd. Financial Instruments Business Operator, The Director-General of Kanto Local Finance Bureau (FIBO) No.3281, and a member of Japan Investment Advisers Association and Type II Financial Instruments Firms Association.

 

In the UK: Issued by Threadneedle Asset Management Limited, No. 573204 and/or Columbia Threadneedle Management Limited, No. 517895, both registered in England and Wales and authorised and regulated in the UK by the Financial Conduct Authority.

 

In the EEA: Issued by Threadneedle Management Luxembourg S.A., registered with the Registre de Commerce et des Sociétés (Luxembourg), No. B 110242 and/or Columbia Threadneedle Netherlands B.V., regulated by the Dutch Authority for the Financial Markets (AFM), registered No. 08068841.

 

In Switzerland: Issued by Threadneedle Portfolio Services AG, an unregulated Swiss firm or Columbia Threadneedle Management (Swiss) GmbH, acting as representative office of Columbia Threadneedle Management Limited, authorised and regulated by the Swiss Financial Market Supervisory Authority (FINMA).

 

In the Middle East: This document is distributed by Columbia Threadneedle Investments (ME) Limited, which is regulated by the Dubai Financial Services Authority (DFSA). For Distributors: This document is intended to provide distributors with information about Group products and services and is not for further distribution. For Institutional Clients: The information in this document is not intended as financial advice and is only intended for persons with appropriate investment knowledge and who meet the regulatory criteria to be classified as a Professional Client or Market Counterparties and no other Person should act upon it.

 

Columbia Threadneedle Investments is the global brand name of the Columbia and Threadneedle group of companies.

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Important Information

For use by professional clients and/or equivalent investor types in your jurisdiction (not to be used with or passed on to retail clients). For marketing purposes.

 

This document is intended for informational purposes only and should not be considered representative of any particular investment. This should not be considered an offer or solicitation to buy or sell any securities or other financial instruments, or to provide investment advice or services. Investing involves risk including the risk of loss of principal. Your capital is at risk. Market risk may affect a single issuer, sector of the economy, industry or the market as a whole. The value of investments is not guaranteed, and therefore an investor may not get back the amount invested. International investing involves certain risks and volatility due to potential political, economic or currency fluctuations and different financial and accounting standards. The securities included herein are for illustrative purposes only, subject to change and should not be construed as a recommendation to buy or sell. Securities discussed may or may not prove profitable. The views expressed are as of the date given, may change as market or other conditions change and may differ from views expressed by other Columbia Threadneedle Investments (Columbia Threadneedle) associates or affiliates. Actual investments or investment decisions made by Columbia Threadneedle and its affiliates, whether for its own account or on behalf of clients, may not necessarily reflect the views expressed. This information is not intended to provide investment advice and does not take into consideration individual investor circumstances. Investment decisions should always be made based on an investor’s specific financial needs, objectives, goals, time horizon and risk tolerance. Asset classes described may not be suitable for all investors. Past performance does not guarantee future results, and no forecast should be considered a guarantee either. Information and opinions provided by third parties have been obtained from sources believed to be reliable, but accuracy and completeness cannot be guaranteed. This document and its contents have not been reviewed by any regulatory authority.

 

In Australia: Issued by Threadneedle Investments Singapore (Pte.) Limited [“TIS”], ARBN 600 027 414. TIS is exempt from the requirement to hold an Australian financial services licence under the Corporations Act 2001 (Cth) and relies on Class Order 03/1102 in respect of the financial services it provides to wholesale clients in Australia. This document should only be distributed in Australia to “wholesale clients” as defined in Section 761G of the Corporations Act. TIS is regulated in Singapore (Registration number: 201101559W) by the Monetary Authority of Singapore under the Securities and Futures Act (Chapter 289), which differ from Australian laws.

 

In Singapore: Issued by Threadneedle Investments Singapore (Pte.) Limited, 3 Killiney Road, #07-07, Winsland House 1, Singapore 239519, which is regulated in Singapore by the Monetary Authority of Singapore under the Securities and Futures Act (Chapter 289). Registration number: 201101559W. This advertisement has not been reviewed by the Monetary Authority of Singapore.

 

In Hong Kong: Issued by Threadneedle Portfolio Services Hong Kong Limited 天利投資管理香港有限公司. Unit 3004, Two Exchange Square, 8 Connaught Place, Hong Kong, which is licensed by the Securities and Futures Commission (“SFC”) to conduct Type 1 regulated activities (CE:AQA779). Registered in Hong Kong under the Companies Ordinance (Chapter 622), No. 1173058.

 

In Japan: Issued by Columbia Threadneedle Investments Japan Co., Ltd. Financial Instruments Business Operator, The Director-General of Kanto Local Finance Bureau (FIBO) No.3281, and a member of Japan Investment Advisers Association and Type II Financial Instruments Firms Association.

 

In the UK: Issued by Threadneedle Asset Management Limited, No. 573204 and/or Columbia Threadneedle Management Limited, No. 517895, both registered in England and Wales and authorised and regulated in the UK by the Financial Conduct Authority.

 

In the EEA: Issued by Threadneedle Management Luxembourg S.A., registered with the Registre de Commerce et des Sociétés (Luxembourg), No. B 110242 and/or Columbia Threadneedle Netherlands B.V., regulated by the Dutch Authority for the Financial Markets (AFM), registered No. 08068841.

 

In Switzerland: Issued by Threadneedle Portfolio Services AG, an unregulated Swiss firm or Columbia Threadneedle Management (Swiss) GmbH, acting as representative office of Columbia Threadneedle Management Limited, authorised and regulated by the Swiss Financial Market Supervisory Authority (FINMA).

 

In the Middle East: This document is distributed by Columbia Threadneedle Investments (ME) Limited, which is regulated by the Dubai Financial Services Authority (DFSA). For Distributors: This document is intended to provide distributors with information about Group products and services and is not for further distribution. For Institutional Clients: The information in this document is not intended as financial advice and is only intended for persons with appropriate investment knowledge and who meet the regulatory criteria to be classified as a Professional Client or Market Counterparties and no other Person should act upon it.

 

Columbia Threadneedle Investments is the global brand name of the Columbia and Threadneedle group of companies.

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