Bond Watch: how will fixed income perform in 2023?

Sam Benstead breaks down the latest news affecting bond investors.

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.

Outlook improved

Following an incredibly poor 2022, experts reckon bonds are now poised to bounce back in 2023. This is because starting yields are now higher after bond prices fell last year, and interest rates are close to peaking, which could put an end to the dramatic repricing of bonds last year as rates rose.

US and UK 10-year bond yields are currently around 3.5% versus 1.7% in the US and a year ago and 1.2% in the UK.

Outlooks from fund groups are very positive on fixed income, with “bonds are back” the typical message from investment professionals.

J.P. Morgan Asset Management says: “Bonds are offering income again and, we believe, will again be a good hedge, regaining their safe-haven status in times of market stress.”

It reckons that if stock markets fall this year, then bond prices will rise, as fixed income will once again become defensive now that central bank interest-rate hiking cycles are nearly complete.

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Fidelity International takes a similar view. Global head of solutions and multi-asset Henk-Jan Rikkerink says: “Looking ahead, we do not expect bonds to perform so poorly or to be as positively correlated to equities in 2023 and we have recently moved overweight government bonds.”

He calculates that a 60/40 portfolio of equities to bonds had one of its worst-ever years last year, but because normal stock and bond correlations will return in 2023, this class portfolio structure will deliver a better outcome this year.

Three investment lessons for 2023

Last year was a wake-up call for investors that a new era had begun, one in which higher interest rates shook up stock and bond market valuations.

BlackRock’s research hub, the BlackRock Investment Institute, says there are three key lessons that investors must take into 2023.

First, it says investors must “widen the lens of possible scenarios” and “beware of inertia and other behavioural biases”. It argues that last year’s shocks – from rapid interest rate rises to energy price increases – will not pave the way for a calmer 2023. Therefore, investors must have quick reactions and adapt to change.

Second, investors must compensate for geopolitical risk, which it says “now warrants persistent risk premia across asset classes, rather than being something markets only react to when it materialises”.

The Investment Institute continues: “We think the war in Ukraine and strategic competition between the US and China are long-term geopolitical risks, not just market drivers of short-lived sell-offs.”

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And third, it says there must be a new investment playbook that includes more frequent portfolio changes because of the new regime of greater macroeconomic and market volatility.

“This means not being lulled into thinking what worked in the past will work now, like automatically buying the dip.”

Unlike J.P. Morgan Asset Management and Fidelity International, BlackRock is not that optimistic on bonds for 2023.

It says: “We don’t count on long-term government bonds as diversifiers. We expect central banks to pause hikes when the economic damage becomes clearer – but keep rates at high levels. We also see long-term yields rising as investors demand more compensation for the risk of holding them amid persistently high inflation and record debt levels.”