Bonds have started to come back from the dead after a horrible performance in 2022.
The iShares Core U.S. Aggregate Bond ETF
(ticker: AGG) has returned 3.8% so far this year, including interest payments. That follows a dismal 2022 performance, when the fund slipped 13%.
“Some things never change. In times of stress, in times of fear you go to the bond market,” says Mark Freeman, chief investment officer at Socorro Asset Management. “That’s clearly what we’ve seen.”
The financial world has experienced significant turmoil since Silicon Valley Bank’s collapse earlier this month—and investors continue to worry about contagion in the banking system.
A big headwind for bonds—whose prices move inversely to their yields—has been the Federal Reserve’s aggressive rate-tightening program. The Federal Open Market Committee boosted rates seven times in 2022. So far this year, the FOMC has increased rates twice, including Wednesday, when rates went up by a quarter of a percentage point.
As rates moved up, bond prices came under pressure.
Treasury yields, however, have dropped sharply in recent weeks. This means that bond investors anticipate that the Fed is close to ending rate hikes—and that the central bank will soon have to start cutting as a recession looms.
The year-to-date improvement in bond performance is occurring across various categories: The iShares National Muni Bond ETF (MUB) is up 2.2% after sliding 7.4% last year. The iShares iBoxx $ Investment Grade Corporate Bond ETF (LQD) has gained 4.5%, a significant improvement after last year’s loss of nearly 18%.
Meanwhile, the iShares high-yield ETF (HYG) is up 1% after falling 11% in 2022. High-yield has lagged some other fixed-income categories this year. No doubt, the prospect of a recession does give some investors pause—given that defaults could rise further.
“Especially in periods of stress, you don’t go out the risk spectrum,” says Freeman.
The iShares TIPS Bond ETF (TIP) has returned 3.3% this year, after sinking about 12% in 2022. Treasury inflation-protected securities are designed to protect investors against inflation, but last year’s surge in the fed funds rate hurt TIPs prices, even as inflation surged.
Meanwhile, treasuries, which are backed by the U.S. government, have done a lot better in 2023, especially at the longer end of the curve.
The iShares 20+ Year Treasury Bond ETF (TLT) is up nearly 8%, a big turnaround from last year, when it finished down 31%. Longer-dated securities have greater exposure to duration risk, or change in rates. When rates go up, bond prices slide, and vice versa.
Lately, investors have been pouring money into the front end of the curve, which has less duration risk and where yields are very attractive.
The six-month T bill was recently yielding around 4.8%, for example. While the two-year Treasury’s yield has dropped sharply lately, it’s at 3.78%, far above the 3.37% for the 10-year Treasury. As that shows, the yield curve remains inverted, though less so than it was a few weeks ago.
It’s hard to predict how bonds will perform for the rest of the year: If the Fed does end up cutting rates, that could give prices a lift. “When the market expects the Fed to go on an easing path, that will be positive for the bond market,” says Freeman. At the same time, the Fed has stated its commitment to curbing inflation back down to 2%.
Write to Lawrence C. Strauss at [email protected]
