Traditionally seen as a safer bet, bonds have been a loss-maker for Irish investors so far in 2022. Stock markets might grab the headlines. But the bond market is bigger, and has been experiencing tough times of its own.
One major bond index, the Bloomberg Global Aggregate, is down nearly 9% for Euro investors over the last 12 months. So what’s driving bond market performance, what do you need to do if you hold bonds, and is the worst behind us?
What’s the bond market?
First, the basics. The bond market is a debt market: it’s where investors go to buy the debt of governments and companies.
Investing in this debt is attractive because it carries fixed interest: as the owner of it, you are typically entitled to regular returns, or yield, as well as to be repaid the face value of the debt at the end of its term.
There’s a huge variety of bond investments, from emerging markets to inflation-linked, investment grade to junk status. Many of us own these bonds via funds which in turn invest in thousands of underlying bond instruments.
What has happened the global bond market?
Put simply, central banks have got serious about inflation, and begun to push up interest rates. That has a direct effect on the rate of return, or yield, on bonds. And the bond market in turn is governed by an iron rule:
When yields rise, bond prices fall.
Central bank balance sheet reduction doesn’t help either
At the same time, central banks are reducing their own bond holdings. Central bank balance sheets ballooned during the Covid-19 crisis, as banks purchased bonds to pump money into the global economy.
Now they are either slowing the rate at which they buy bonds (also known as tapering), selling bonds into the market, or declining to reinvest the money when bonds mature.
Taken together, these rising yields and central bank disposals are depressing the price of bonds.
Keep it in perspective
Right now, bond yields are at relatively high levels, last seen in 2018 and 2011. 10-year US bonds are north of 3%.
In plain English, this means relative demand for US government debt is low, and therefore investors are expecting a higher yield to invest in it.
Many Irish investors and pensions holders will own bonds as part of a diversified portfolio – perhaps in a 60:40 mix. Most of the time, this balanced position in bonds helps dampen periodic downturns in the stock market.
So far 2022, that hasn’t proven the case. That doesn’t mean a balanced portfolio approach is wrong. Every pullback is a little different, and in 2022, bond markets have been hit with bad news at the same time as equity markets.
There is still value – and future protection – in being diversified among equity funds, bonds, and other assets. If you went into 2022 appropriately diversified, it’s likely you will do best by holding your nerve.
So is the worst behind us?
Investors have had a lot to digest in the first four months of 2022. And it is highly likely there will be heightened volatility in the coming weeks and months. But it is also true that the market has now priced in the plans of central banks to tighten interest rates and reduce the size of their balance sheet.
Irish investors can take some confidence from the words this week of John Madziyire, head of US Treasuries and Inflation at Vanguard, one of the world’s biggest bond market investors:
“Yields can still go higher as a function of the fact that volatility is so high, but we’re probably getting close to a point where we’re pricing in the highs in yields and buyers will start being more attracted to buying at these levels,” he said.