Bond Watch: what will bonds return over the next decade?

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.   

• Invest with ii: Investing in Bonds | Free Regular Investing | Open a SIPP

Here’s what you need to know this week. 

How will bonds perform over the next decade? 

Via its giant LifeStrategy range, which uses passive funds to give investors balanced exposure to stocks and bonds, fund manager Vanguard is one of the most common ways that UK investors access bond markets. 

Therefore its investment return forecasts are an important indicator of what LifeStrategy investors may make on their investments.  

In its updated outlook for 2024 and beyond, the US fund group said that “bonds are back” and it now expects US bonds to return an annualised 4.8%–5.8% over the next decade, compared with the 1.5%–2.5% it expected before the rate-hiking cycle began in 2021. 

For international bonds, it expects annualised returns of 4.7%–5.7% over the next decade, compared with a forecast of 1.3%–2.3% when rates were low or, in some cases, negative. 

• How fund manager predictions fared in 2023 – and forecasts for next year
• The best and worst-performing funds of 2023
• Bonds expected to be the best-performing investment in 2024

This shows that higher interest rates have provided a fantastic reset for bond investors, and expected returns are now substantially higher than before the rate rising cycle began in late 2021.  

But it is not so positive on equities. Vanguard says that “valuations” are most stretched in the US and as a result it has downgraded its US equity return expectations to an annualised 4.2%–6.2% over the next 10 years, from 4.4%–6.4% heading into 2023. 

This means that bond and equity return expectations are relatively similar, which should bode well for more risk-averse investors who are drawn to LifeStrategy funds with high allocations to bonds.  

How will the UK economy perform in 2024? 

The outlook for the UK economy is closely linked to the outlook for the bond market, with lower inflation and steady economic growth likely to boost bonds, while any indication that interest rates will have to stay high to bring down higher than expected inflation likely to lead to falling bond prices (and therefore higher yields).  

So, what is in store for the economy in 2024? 

Consultancy KPMG reckons that gross domestic product will continue to grow at a modest pace of 0.5% in 2024, and only pick up towards its steady-state rate of around 1% in 2025. 

• Investors buy shares as interest rate cuts loom
• Falling interest rates will trigger a small-cap recovery
• The UK stock market outlook for 2024

The chief economist Yael Selfin says that because inflation is now around 4%, the UK is no longer an outlier compared to other major economies.  

“But domestic influences – including a tight labour market, strong services price inflation, and firms passing on higher costs to consumers – continue to keep core inflation elevated,” she adds. 

Therefore, Selfin reckons that the Bank of England will only normalise interest rates when it’s confident that inflation is firmly on target. 

“That’s unlikely to happen before the latter part of 2024,” she said.