Investing and Saving
Could 2024 be the year of the bond?
By Jason Crumley 15 January 2024 5 min read
Investment returns over the last few years and into 2024 suggest this could be an interesting year for bond investors. After the record pace of interest rate increases, central banks could finally be in a position to offer monetary policy relief, which could lead to a decline in interest rates in 2024. As bond prices generally increase with declining interest rates, this could position bonds for another strong year.
Bond yields remain at historic highs
Source: Bloomberg
Four reasons 2024 could be a good year for bond investors
So what can we look forward to in 2024 and could this be an opportunity for bond investors? It is important to first understand the relationship of interest rates and bond prices. When central banks raised rates in this most recent economic cycle, bond prices generally declined from mid 2020 until the third quarter of 2023 when bonds rallied into the end of the year. This rally was precipitated by the belief that central banks would ease monetary policy and reduce rates in 2024. This expectation of a rate reduction pushed bond prices higher and reduced yields in late 2023.
With that in mind, we look at four factors that could reward bondholders in 2024, as well as some of the risks they face.
1. Moderating inflation
There were a variety of factors that brought the interest rate environment to where we are now and the one major contributor was rapidly rising inflation. During the global pandemic, supply chain disruptions led to challenges associated with business planning and product output which in turn contributed to scarcity of many items such as household goods, leisure items and vehicles. Consumers and businesses have witnessed a slowing inflation pressure, or disinflation since the third quarter of 2022. The supply chain disruptions that once fueled rising costs have moderated and created a more stable price environment. Additionally, global concerns over slowing economies have tempered demand for commodities such as oil and suppressed the price of fuel. Investors, policymakers and consumers find themselves navigating a landscape where the once rapid price increases for goods and services are moderating.
Moderate or falling inflation rates allow investors to preserve their purchasing power with the fixed-interest payments from bonds. Inflation erodes the real value of future cash flows, making the predictable income from bonds more appealing in a low-inflation environment. Relating to inflation, a risk to bond investors would be hints that inflation is re-emerging.
Disinflation is moderating pricing pressure
The cost of goods and services is slowly easing.
Source: Bloomberg
2. Central bank policies
Central banks, acting as the architects of monetary stability, have expressed confidence that the aggressive interest rate increases throughout 2022 and into 2023 have brought inflation down to a more acceptable level but still above the Fed’s target rate of 2%. This could facilitate a policy shift in 2024 to ease monetary policy and lower interest rates. In 2023 we witnessed central banks shift from a hawkish tone of tighter monetary policy to a dovish tone, suggesting that rate cuts are on the horizon.
In 2022, global central banks started to aggressively battle inflation through monetary policy and began to increase interest rates. This continued into 2023 as consumers became concerned about the state of the economy and increasingly deferred major purchases due to higher rates of borrowing. Inflationary pressure began to ease in 2022 and continued to decline in 2023 as the effects of rising rates ripple through the economy and provided a headwind to the rising cost of various goods and services. While certain elements of inflation remain elevated, investors breathed a collective sigh of relief as both equity and bond markets rallied heading into the end of 2023.
Relating to central bank policies, investors should watch the tone from central bankers. A more hawkish policy tone due to continued economic strength in a variety of areas could delay the expected monetary policy ease.
3. Lower interest rates
If central banks decide to ease their monetary policy and reduce rates, we could see a meaningful decline in central bank rates globally which could serve to increase bond prices. While many are forecasting that rates will decline in 2024, there is significant debate surrounding the frequency and magnitude of the decline.
Central bank rates and government bond yields
Bond yields have increased alongside the rapid rise in central bank policy rates.
Source: Bloomberg
According to interest rate traders, the expectation is rates will decline by 25 basis points at seven out of the next eight Federal Reserve meetings in 2024. If this holds true, US rates could decline by 1.75% by the end of 2024. In Canada, a survey of 24 economists indicate the median expectation is rates will decline by 1% bringing the overnight rate in Canada to 4%. These shifting expectations pose a risk to investors because roughly 1.75% of cuts are already priced into the market, and any material change in these expectations could have an impact on markets. For example, if rates stay higher than expected for longer (less rate cuts), this could create headwinds for equity markets over concerns of prolonged restrictive monetary policy and keep rates higher on bonds for longer.
Futures market predicting a number of rate cuts in 2024
This chart shows the implied overnight rate based on futures contracts and the number of cuts expected by traders.
Source: Bloomberg
4. A safe haven
Despite the highly unusual negative performance of both equity and bonds in 2022, bonds have proven to be a safe-haven asset in times of economic uncertainty or market volatility. Government bonds, particularly those issued by economically stable countries, are generally much lower risk than their equity counterparts. Increased demand for these bonds can drive up prices, resulting in bond market outperformance. Additionally, heightened geopolitical tensions often cast a shadow over financial markets. In such an environment, the relative safety of bonds emerges as a beacon for risk-averse investors. The consistent income streams and capital preservation attributes of bonds provide an element of increased safety from the uncertainties emanating from geopolitical events, making them an appealing choice in a world fraught with unpredictability.
Diversification is key
Understanding these market cycles and general economic conditions is crucial for investors looking to construct well-balanced portfolios that can weather different market environments. It's important to note that while bonds may have strong performance in certain conditions, the overall investment landscape is dynamic, and diversification remains a key principle in managing risk. Potential risks such as an inflation resurgence or a shift in policy back to a more hawkish tone could provide headwinds for bond investments in 2024. The credit environment is another factor to be aware of. Both business and consumer credit delinquencies have been increasing and could provide headwinds for a credit product such as bonds. Allocation to major asset classes such as equity and bonds is an important consideration for all portfolios and evaluating the current state of your investment portfolio compared to risk and return expectations is always a good idea. Investors seeking a sanctuary from market volatility may find solace in the relative predictability afforded by bonds as central banks navigate the delicate balance between growth and stability.
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