Investors may be able to lock in 5% bond returns for five years or more in 2023, according to Kathy Jones, chief fixed-income strategist for Charles Schwab.
“It has been a long time since we have been able to say that,” Jones said in an interview.
Bond returns were held down for so long, and 2022 saw a “brutal drop” in bond prices, lifting interest rates up to more normal levels. The result is that a reasonable, less risky return looks attractive for the New Year, she added. “We are talking about high-quality corporate bonds, U.S. Treasurys and munis.”
Jones predicted continued volatility for 2023 that would make equities unstable. “But it is always about the balance. Those people who underweighted bonds during the last few years may want to increase their allocations.”
Jones recently wrote an article for Schwab entitled, “Fixed Income Outlook: Bonds Are Back.” She argued that bonds are poised for a comeback that could help investors (especially those in or near retirement) realize income. Schwab favors intermediate- to long-term bonds and laddered bonds over short-term products.
The optimistic outlook for bonds is based on several factors. Starting yields for bonds are higher than they have been in several years, both in nominal and real terms; the Federal Reserve Board will probably stop raising rates by midyear; and inflation should slow.
Current conditions are already pointing to a good year in 2023 for bonds, Jones said. Yields for five- and 10-year bonds are higher than they have been since 2009.
“High real yields in risk-free Treasurys mean investors don't have to look to riskier segments of the market for returns that will beat inflation,” Jones explained. “Moreover, by raising the cost of capital to businesses and households, high real yields tend to slow economic growth,” which also makes bonds more attractive compared to equities.
Of course, there could always be disruptions to the sunny outlook for bonds. The major risk would be a resurgence of inflation, which could be caused by factors as far away as China and Ukraine. If China opens its economy more rapidly than expected from its current Covid lockdown, it could push inflation back up in the United States. Likewise, if there is an increase in U.S. domestic spending that is stronger than anticipated, it would increase inflation.
“These are factors we are watching, but given the amount of global tightening in monetary policies year to date, the risks appear skewed to slower growth and lower inflation,” Jones concluded.
If bond yields hold at 3% to 3.5% until the end of the year “we suggest investors continue to increase [bond] durations, keeping the average near an investor's long-term benchmark. Our message is one of optimism for bond investors,” she said.