Bond Watch: here’s why bond prices keep on falling

Welcome to interactive investor’s ‘Bond Watch’ series, covering the latest market and economic news – as well as analysis – that is relevant to bond investors.

Our goal is to make the notoriously complicated world of bond investing simpler, by analysing the week’s most important news and distilling it into a short, useful and accessible article for DIY investors.

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Here’s what you need to know this week.

Bond sell-off enters new leg

Professional investors have been calling the bottom of bond markets for some time now, expecting yields to peak, therefore giving investors a great entry point into fixed income.

But yields continue to rise, particularly for longer-dated bonds, a result of lower bond prices.

Take the 30-year gilt for instance, it now yields 5% compared with about 4.5% three months ago. It’s the same story in America, where the 30-year treasury bond yields 4.9% compared with just 4% three months ago.

While short bonds bore the brunt of the pain at the start of the year, which was a consequence of investors betting that rates would continue to rise this year but fall next year, investors are now beginning to price in higher interest rates for longer. This is because economies have been extremely strong  despite the effects of higher interest rates.

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While anyone listening to central banker comments should not be surprised by this, markets had previously thought that the bankers were bluffing and would indeed be forced to step in to cut rates soon to rescue economies from the pain caused by higher interest rates.

Investors could stomach high short-term rates so long as over the medium term they fell. Now the reality of higher for longer is being priced in.

Matthew Henly, fixed income portfolio manager at fund group Invesco, explains: “Bond yields have been rising primarily due to expectations that economic growth will hold up better than feared, particularly in the US. Consequently, the market has moved to price in a ‘higher for longer’ interest rate environment.

“This was partly fuelled by the September Federal Reserve meeting in which the average projected policy rate was revised upwards by 0.5% by the end of 2024. Longer-dated bonds have fared worse given more expensive valuations and a growing sense from investors that while central bank interest rate hikes may well be behind us, rates could stay at elevated levels for longer than previously expected.”

Retail investors react by selling bonds

Private investors pulled money from bond funds in August, according to data from fund industry trade body the Investment Association.

It found that £356 million was taken out of fixed-income funds during the month, the first outflow since October 2022.

This includes a net £174 million moving into gilt funds, meaning that corporate bond funds were a big casualty in August.

Investors had been consistently adding bonds to benefit from higher yields, but recent falls in bond prices, because of markets pricing in higher rates for longer, may have spooked investors.

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Nevertheless, pain in the bond market increases expected returns for new investors, as falling bond prices creates higher yields.

Those looking to buy bonds for income could look to reduce “duration” risk in their portfolios. A bond’s duration is its sensitivity to interest rates, with higher interest rates having a negative effect on the price of bonds with a greater duration.

Low-duration bonds will generally have a shorter time to maturity, therefore investors looking to protect against bond price falls could look at short-dated bond funds.

Popular strategies include abrdn Short Dated Corporate Bond, M&G Shorted Dated Corporate Bond, and iShares £ Corporate Bond 0-5 yr Ucits ETF.