In March, central banks around the world were virtually unanimous in their decision-making on interest rates. The Bank of Canada, the U.S. Federal Reserve, and the Bank of England, amongst others, all held interest rates where they’ve been for months.^{1 2 3}

While many businesses and investors would like to see rates come down, central banks continue to use interest rates as a tool to curb inflation, which remains above their two percent-per-year targets for now.

However, these central banks have signalled that with inflation trending slowly downward, the climate may be right for interest rate cuts soon. This has left financial markets abuzz with anticipation of declining interest rates in the latter half of this year.⁴ This expected monetary shift has sparked a renewed interest in bonds and promises to reshape the market for these securities.

The relationship between interest rates and bonds has long been a fundamental principle of investing. As we look ahead to this potential shift in monetary policy on the part of central banks around the world, it’s crucial to understand how these changes will determine the bond market in 2024 and what investors might expect in terms of opportunities and returns.

Interest Rates and the Bond Market

The bond market is inextricably linked to the ebbs and flows of interest rates. The key thing to understand as an investor is the inverse relationship between bond prices and interest rates.

When rates fall, the price of existing bonds with higher interest payments due to the holder becomes more attractive, causing their value to rise. Conversely, rising rates can lead to lower bond prices since new bonds would likely be issued at these higher rates, making existing bonds with lower payments less appealing.⁵

The inverse correlation stems from the fact that bonds come with a fixed interest rate, known as the ‘coupon rate,’ determined at the time of issuance. This fixed rate necessitates adjustments in pricing within secondary markets based on prevailing interest rates when existing bonds are traded. When interest rates rise, newly issued bonds offer high yields, making them more appealing to investors. Consequently, older bonds with lower rates see their prices decrease to attract buyers.⁶ This inverse relationship is a cornerstone of bond investing, impacting decisions across the spectrum from individual bonds to bond funds.

To maximize investment returns, consider acquiring bonds during periods of elevated interest rates. During such times, bond yields are higher, resulting in more substantial returns on investments compared to periods with lower interest rates.⁷

Expectations for the 2024 Bond Market

With the anticipated rate cuts, the bond market in 2024 is positioned for a noticeable pivot. As the Federal Reserve, the Bank of Canada, and other central banks signal a downward adjustment in rates later this year, the ramifications for the bond market are twofold.

Firstly, existing bondholders might see an appreciation in the market value of their bonds. Secondly, new issuances could potentially offer lower yields than we’ve seen in the recent high-rate environment.8

While returns are expected to improve from their current standings, investors would be wise to have a moderated outlook about the near-term future of the bond market for several reasons.

For one, the global economic recovery post-pandemic has been uneven, influencing inflationary pressures and, subsequently, central bank policies worldwide. Moreover, initial rate cuts may be fairly conservative, as policymakers balance stimulating growth with keeping inflation in check.9 As such, while the bond market is likely to experience an uptick in performance, investors should anticipate more modest gains.

The Long-Term Appeal of Bonds

Despite the restrained expectation for short-term gains, several factors in the current environment make the long-term allure of bonds attractive.

Firstly, the anticipated lower rate environment enhances the appeal of holding bonds for those with a longer-term investment horizon. Long-term bonds, like 10-year Treasury bonds, offer a fixed income stream and purchasing them in a declining rate environment can lock in higher yields relative to the future.¹⁰

Furthermore, bonds contribute to portfolio diversification, serving as a counterbalance to the volatility of stocks. In times of economic uncertainty or market turbulence, bonds typically offer a safe haven, preserving capital while providing a steady income. The expected economic conditions in 2024 and beyond, marked by cautious optimism but lingering uncertainties, underscore the relevance of bonds in a well-structured investment portfolio.¹¹

Additionally, for investors focused on managing risk, bonds offer a spectrum of options, from high-yield bonds offering greater returns (albeit at higher risk) to government and municipal bonds known for their stability. As rates start to come down, the risk-return profile of these bonds will shift, potentially offering more attractive entry points for long-term investments.¹²

Strategic Considerations for Investors

Given this outlook, investors should consider several strategic moves. Rebalancing portfolios to incorporate a mix of bond types, maturities, and yields can optimize returns while managing risk. Investors may also look to ladder their bond investments, purchasing bonds with different maturities to benefit from changing interest rates over time.¹³

While the immediate outlook suggests improved returns, the path to significant gains appears measured. Nonetheless, the environment heralds promising long-term opportunities for bond investors. By understanding the nuanced dynamics at play and adopting a strategic approach, investors can leverage the evolving bond market to bolster their portfolios, balancing returns with risk in a period marked by cautious optimism and financial recalibration.

ETF Options for Bonds

If you’re looking for an opportunity to diversify your portfolio with fixed-income holdings like bonds, one option is investing in fixed-income ETFs.

Evolve Enhanced Yield Bond Fund (BOND ETF) provides investors with a low-cost fixed income solution that seeks to deliver attractive monthly income and long-term capital appreciation. To enhance yield, as well as mitigate risk and reduce volatility, BOND will initially employ an active covered call option writing program on 50% of the portfolio.

For more information on Evolve Enhanced Yield Bond Fund (BOND ETF), explore fund details here.

For more blogs like this, and for insight on investing and investment products, sign up for our weekly newsletter here.

 

Sources

1. Armstrong, P., “Bank of Canada worries a rate cut now could overheat the spring housing market,” CBC News, March 7, 2024; https://www.cbc.ca/news/business/housing-interest-rates-bank-of-canada-1.7135766
2. Schneider, H. & Saphir, A., “Fed sees three rate cuts in 2024 but a more shallow easing path,” Reuters, March 21, 2024; https://www.reuters.com/markets/rates-bonds/feds-rate-cut-confidence-likely-shaken-not-yet-broken-by-inflation-2024-03-20/
3. Smith, E., “Bank of England holds rates but says ‘moving in the right direction’ for cuts,” CNBC, March 21, 2024; https://www.cnbc.com/2024/03/21/bank-of-england-holds-interest-rates-at-5point25percent.html
4. Schleich, T. & Lovely, W., “Monthly Fixed Income Monitor,” National Bank of Canada, March 2024; https://www.nbc.ca/content/dam/bnc/taux-analyses/analyse-eco/mensuel/monthly-fixed-income-monitor.pdf
5. Lioudis, N., “Inverse Relation Between Interest Rates and Bond Prices,” Investopedia, February 27, 2024; https://www.investopedia.com/ask/answers/why-interest-rates-have-inverse-relationship-bond-prices/
6. Mittal, V., “What Is the Inverse Relationship Between Bond Price and Bond Yield?,” Aspero, February 23, 2024; https://www.aspero.in/blog/what-is-the-inverse-relationship-between-bond-price-and-bond-yield/
7. Lioudis, N., “Inverse Relation Between Interest Rates and Bond Prices,” Investopedia, February 27, 2024; https://www.investopedia.com/ask/answers/why-interest-rates-have-inverse-relationship-bond-prices/
8. Schleich, T. & Lovely, W., “Monthly Fixed Income Monitor,” National Bank of Canada, March 2024; https://www.nbc.ca/content/dam/bnc/taux-analyses/analyse-eco/mensuel/monthly-fixed-income-monitor.pdf
9. “Chart Book: Tracking the Recovery From the Pandemic Recession,” Center on Budget and Policy Priorities, March 25, 2024; https://www.cbpp.org/research/economy/tracking-the-recovery-from-the-pandemic-recession
10. DiMaggio, S., “Fixed-Income Outlook 2024: Bonds Roar Back,” AllianceBernstein, January 2, 2024; https://www.alliancebernstein.com/corporate/en/insights/investment-insights/fixed-income-outlook-2024-bonds-roar-back.html
11. Wohlner, R., “Portfolio Diversification Explained: Definition, Importance, Strategy,” Time, March 10, 2024; https://time.com/personal-finance/article/importance-of-diversification/
12. “Investor Bulletin: Municipal Bonds – Asset Allocation, Diversification, and Risk,” U.S. Securities and Exchange Commission, February 1, 2018; https://www.sec.gov/oiea/investor-alerts-and-bulletins/ib_munibondsrisk
13. Kopp, C.M., “Bond Laddering: How it Works, Benefits, Variations,” Investopedia, May 23, 2022; https://www.investopedia.com/terms/b/bondladdering.asp

 

Header Image Source: Getty Images

The contents of this blog are not to be used or construed as investment advice or as an endorsement or recommendation of any entity or security discussed. These contents are not an offer or solicitation of an offer or a recommendation to buy or sell any securities or financial instrument, nor shall it be deemed to provide investment, tax or accounting advice. The information contained herein is intended for informational purposes only.

Commissions, management fees and expenses all may be associated with exchange traded funds (ETFs) and mutual funds (funds). Please read the prospectus before investing. ETFs and mutual funds are not guaranteed, their values change frequently, and past performance may not be repeated. There are risks involved with investing in ETFs and mutual funds. Please read the prospectus for a complete description of risks relevant to ETFs and mutual funds. Investors may incur customary brokerage commissions in buying or selling ETF and mutual fund units.

Certain statements contained in this blog may constitute forward-looking information within the meaning of Canadian securities laws. Forward-looking information may relate to a future outlook and anticipated distributions, events or results and may include statements regarding future financial performance. In some cases, forward-looking information can be identified by terms such as “may”, “will”, “should”, “expect”, “anticipate”, “believe”, “intend” or other similar expressions concerning matters that are not historical facts. Actual results may vary from such forward-looking information. Evolve Funds undertakes no obligation to update publicly or otherwise revise any forward-looking statement whether as a result of new information, future events or other such factors which affect this information, except as required by law.