A terrible year for bonds

2022 was a year bondholders would rather forget. The rapid climb in interest rates across the world reverberated across all bond segments. The impact on the bond portfolios’ market value was so strong that 2022 ended up as the worst calendar year in history. It is especially true for long term Treasury bonds. For example, the NAV of the iShares 20+ Year Treasury Bond ETF declined by 31.40%.

The yield on the benchmark 10-Year U.S. Treasury Note rose 237 basis points from 1.51% to 3.88% after touching 4.24% in October, its highest since 2007. Even more striking is the fact that the yield on the short-term 2-year U.S. Treasury Note jumped from 0.73% to 4.42%. The spread between the 2-year and 10-year yields has inverted since early July. Yield-curve inversions – i.e. when shorter-term government bonds have higher yields than longer-term ones despite carrying lower risk - are usually viewed by economists and investors as signs that a recession is imminent.

Investors in European T-bonds even felt a bit more pain. The yield on the German 10-year Bund jumped from -0.18% to 2.57% (up 275 basis points).

Investment grade corporate bonds had a miserable 2022 too. The IBOXX € Liquid Corporates index was down 13.83% while the IBOXX Ishares $ Investment Grade Corporate Bond Index plunged 16.72%.

High-yield bonds lost 9.41% in Europe (IBOXX € Liquid High Yield Index) and 8.77% in the U.S. (Markit iBoxx USD Liquid High Yield Capped Index).

Emerging debt in local currencies fell 14.39%.

Now 2022 is in the rear-view mirror, what can we expect in 2023?

Even if past performance is not indicative of future results, the current level of bond yields may be a good entry point for long term investors who think we have passed inflation peak as the most recent consumer price indexes seem to indicate. That said, we should bear in mind that the magnitude of inflationary pressures is still high. The central banks are facing a complex challenge. How to reduce the size of their balance sheet while not driving the global economy into a deep recession?

After the big downturn of 2022, the bond markets may rebound in 2023 provided that the Federal Reserve and its peers do not make another mistake with their overly restrictive monetary policy. Fundamentals will likely deteriorate in the first half of 2023 as financial conditions continue to tighten but, after a year of macroeconomic and geopolitical shocks, we can also expect that central banks will pivot and signal cutting interest rates sometime next year, which could lead to a sustained recovery of bond prices.

Please note this article is for information purposes only and does not in any way constitute investment advice. It is essential that you seek advice from a registered financial professional prior to making any investment decision.