There are encouraging signs that bond investors will have a better time next year after a disastrous year in 2022.
Having been hit by runaway inflation and the Fed surprise rate hikes for much of the year, U.S. Treasuries are regaining positive returns and total market returns are expected to be positive for a second month in a row. This is supported by the current rise in yields and a rebound in bond prices fueled by recession fears and signs that gains in consumer prices are slowing.
Of course, this is a small consolation after one of the biggest losses in at least half a century. But recent market-moving factors suggest that the pain for bondholders may ease in 2023. The yield on the benchmark 10-year U.S. Treasury note ended last week at 3.75%, more than half a percentage point below its October high. And with the Fed vowing to keep raising rates to really break inflation, expectations are rising for an economic downturn next year, which could continue to put downward pressure on yields.
“Fixed income is going to add value to investors over the next 12 months, maybe 24 months,” Mark Cabana, head of strategy at Bank of America U.S. rates, said in an interview last week. "You're going to see that yields could come down, and yields have value again in portfolios. Investors should be thinking more constructively about fixed income broadly."
The rise in yields also means that bondsrelative tostocks is more attractive. With the prospect of a recession clouding the outlook for corporate America, the pro forma dividend yields on stocks look less attractive compared to fixed income.
If bond prices fall, “you have a cushion now,” Jim Bianco of Bianco Research said this week. "Interest rates are at levels not seen in 15 years."
In the final holiday-shortened trading week of 2022, there are few events planned that could reshape fundamentals. But the market itself still has some room for turmoil given thin liquidity and an upcoming series of coupon-bearing bond tenders.
Meanwhile, interest rate enthusiasts will also focus on potential problems in short-term funding markets. Repo rates suggest traders are expecting a relatively quiet end to the year, but that's not necessarily the reality, and any disruption has the potential to roil currency markets broadly, meaning it remains a key risk as a tumultuous 2022 nears the end of history .
