Income is back: five reasons to invest in bonds in 2024

Bonds are back. After a couple of barren years, yields in high-quality bonds that were not too long ago returning just 2 or 3% are now set to bring in 7 to 8%.

The jump in yields looks to be a game changer for investors. Those once demanding returns of between 6 and 8% from their wealth managers would have had little option but to scrape the bottom of the barrel and go down into the treacherous world of CCC credit. But now we think they should be able to obtain those yields with good quality bonds.

We think the ability for investors to get the outcomes they want from fixed income, in a stable and reliable fashion, is back, and so here are the five biggest reasons why we believe bonds will be such an important investment in 2024.

1. The cost of cash has increased

The last two years in fixed income have been difficult for investors. Perhaps it is not surprising then that so many turned to cash, or near cash, especially government bills, in order to help protect capital.

This capital preservation trade seemed to make perfect sense. But as we reach terminal rates we do not think this narrative continues to be the case. The opportunity cost right now of having no duration, and therefore assuming outsized reinvestment risk with portfolios that are supposed to have relatively long investment, has now tilted so far the other way that we would argue staying in cash could be doing a disservice to clients over the coming years.

We can now say with confidence: the opportunity cost of staying in cash is likely now very high indeed. Read more about the cost of staying in cash  here.

2. The end of rising interest rates

Much of the volatility seen in the fixed income market over the last couple of years was caused by the rates headwinds. The fact that central banks were battling inflation meant they were pushing base rates higher and adopting a restrictive monetary policy that ultimately tightened monetary conditions and negatively impacted bond investors.

Although that war on inflation might not be fully won just yet, it does feel like we are getting closer to a victory. The message investors are getting from central banks across the globe is that we are now at peak rates.

As a result, we do not expect government bonds to be a major headwind for the market in 2024. Central banks are hinting at cuts, with many still predicting that the US Federal Reserve will make its first rate cut as soon as March. Although we think this might be a little too soon, the end of rising interest rates and the arrival of a new world in which they slowly start to fall is very promising indeed.

3. Attractive yields

Outright yields now available in the bond market are much more attractive than they have been for a very long time. From long-dated government bonds to investment grade and high-yield instruments, the yields you can now get are far higher than they were during the recent cycle of rising interest rates.

So, what does that mean? Well, in short, investors can get the income they want without having to take on as much risk as they did in the past. Investors should no longer need a combination of high-risk strategies to achieve attractive returns, most can now find what they need in less volatile, high quality, fixed income products.

High-quality bonds that were not too long ago yielding just 2 or 3% are now available at 6, 7 or 8% and that is a game changer for investors. With inflation expected to fall towards the 2% target in coming quarters, the real return investors can get from fixed income will look much more attractive.

4. A brighter economic outlook

Not long ago, talk of savage recessions and tumbling economies were the base case for many strategists and commentators but that has now changed radically.

The base case for most investors, including our own house view, is one of a soft landing or a mild recession — and neither of those should be bad for credit. What is traditionally bad for credit is a hard landing; that creates spluttering economies and a landscape in which default rates spike.

If there is a recession, we think it will be mild. A lot has changed in the last 12 months and the rosier outlook for economies with inflation finally looking tamed, should present much improved opportunities for bond investors.

5. Defaults should remain under control

The brighter economic outlook has a direct impact on companies’ financial ratios. The good financial condition of banks, firms and consumers before the hiking cycle started has meant that the expected deterioration in credit ratios looks to have  been contained and has come from very healthy levels by historic standards. Consequently, default rates have been lower than many predicted, which is also reflected in companies’ credit ratings.

Time to re-engage with bonds

The upshot is we are confident bond investors have many reasons to be optimistic in 2024. After severe bouts of market volatility and central bank rate hiking, we think the conditions are set for one of the most promising years in fixed income for a long time. Investors should be able to find an attractive level of income for any given level of risk tolerance in the context of higher yields, contained defaults and falling inflation.