Bond Watch: why investors got 2024 wrong

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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Where did the rate cuts go?  

A year ago, it was widely expected that central banks would cut interest rates in 2024, due to forecasting of stuttering economies and lower inflation in 2024.  

But while inflation did slow, and the UK economy stalled, interest rates did not move as much as anticipated. 

Markets were pricing in 1.5 percentage points of cuts in the US and UK – or six 0.25 point cuts. In the US, they got three 0.25 point moves, but in the UK there was just two, taking rates to 4.75%.  

Because interest rate cuts were priced into bond markets at the end of the last year, and they did not materialise in the ways markets expected, bond markets actually sold off this year and most investors lost money even when accounting for coupon income.  

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Fewer rate cuts combined with rising inflation in the UK, where prices rose 2.3% annually in October and 2.6% in November, meant that bond yields rose this year as markets repriced. The 10-year gilt yield rose from 3.5% to 4.5%, meaning that investors suffered a drop in their capital value.  

Investors are also worried that tax increases by the new government in the UK may lead to higher inflation, as employers pass on the extra cost of employers’ National Insurance.  

The worst fixed-income sector was UK Index Linked Gilts, where bond prices are among the most sensitive to interest rate changes due to their long maturity dates. The average fund in this sector dropped 9.3%.  

Conventional gilts also performed poorly, with the average gilt fund dropping 3.7%. Emerging market bonds, European government bonds and global government bond funds also dropped this year. 

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UK interest rates are again expected to fall in the coming year, with the Bank of England itself predicting four cuts, to take the base rate down to 3.75%. With gilt yields at more than 5% for the longest bonds, about 4.5% for the medium-term bonds and a little less for those maturing in under five years, we enter the new year in the opposite scenario to last year: the market expects fewer rate cuts than the central bank. 

This year, markets were wrong. If they are wrong again next year then contrarians – those buying bonds at elevated yields – could be the winners. Only time will tell!