Why it may be time to return to fixed income investing

Rising inflation and retreating Federal Reserve stimulus have sent bond yields higher in 2022. In fact, in the first five months of the year, yields for high-quality bond investments have nearly doubled to 3.3%.

Like when stock markets pull back, the recent rise in yields hits a reset button for opportunities across fixed income investments. (Remember: As yields rise, bond prices fall.)

Here are our predictions for the bond markets and why it may be time for investors to return to long-term fixed income investing:

Income has returned to fixed income

Income investors have been starved by falling investment distributions over the past decade — especially when it comes to fixed income.

Current levels are the highest in over a decade, punctuating why bond yields today are so remarkable. The yield on the Bloomberg US Aggregate Index stands modestly below levels last seen in the fourth quarter of 2018, just before Fed policy rates peaked and subsequently shifted focus to the late stage of the investment cycle.

Difficult total returns may be behind us

Source: Bloomberg, American Enterprise Investment Services, Inc. Date as of 5/26/2022. Barclays Bloomberg US Aggregate was rebranded Bloomberg US Aggregate in August 2021. This example is shown for illustrative purposes only and is not guaranteed. Past performance is not a guarantee of future results.

While higher yields in today’s bond markets stand out as a positive, the sharp rise in yields led to the worst quarterly total return on the Bloomberg US Aggregate Index in more than 40 years in the first quarter. For most investors, the plunge was a stunning move for fixed-income portfolios and the greatest in generations. After further negative returns in April, we believe yield levels may have fully reset.

Beyond the near term, we view current fixed income yields as attractive for investors, given our view that yield levels and inflation readings may have peaked. Bond markets already reflect tighter Fed policy and peak inflation. Ten-year Treasury yields found a new, near-term trading range of around 3%. We believe the peak in Treasury yields in early May could serve as a notable high watermark for 2022.

While it’s natural to want to avoid duplicating or extending losses, we believe the path ahead likely takes a different course. Though high-quality bond prices may decrease and yields may increase over the near term, we believe we have already seen the correction linked to a Fed policy retreat and the inflation spike.

All bond investors benefit from higher yields

There is good news for bond investors:

  • Favorable tailwinds for returns: When 10-year U.S. Treasury yields were at 1%, it took only a modest decline in price to send total returns into negative territory. Higher bond yields boost the tailwind from coupon returns, a dynamic that will build over time as principal is reinvested as bonds mature.

  • Higher yield for investors drawing income off investments: Given the nearly doubling in yield since the end of last year, investors can now generate income near the highest level of the past decade.

    Source: Bloomberg, American Enterprise Investment Services, Inc. Data as of 05/27/2022. This example is shown for illustrative purposes only and is not guaranteed. Past performance is not a guarantee of future results.

  • Potential to hold ground against inflation: Investors focused on short-term bonds to preserve principal may find yields more intriguing with each Fed rate hike. We may not be far off from short-term bond yields providing a real, inflation-adjusted yield, either. It’s been a while, to be sure, but a year from now, we may be talking more about it.

Returning to long-term fixed income investing

Over the next year, we forecast growth and inflation to slow in response to Fed policy tightening. As a result, we believe the window may be opening to reposition fixed income portfolios. The legacy negative correlation between U.S. Treasuries and stocks returned in May, benefiting diversified long-term portfolios.

To the extent market volatility and negative returns sent investors to the sidelines, we believe it’s time to get back to long-term fixed income investing. Contact your Ameriprise financial advisor for personalized advice that’s tailored to your time horizon, risk tolerance and financial goals.