Interactive Investor

Bond Watch: what will bonds return over the next decade?

Sam Benstead breaks down the latest news affecting bond investors.

29th December 2023 08:32

by Sam Benstead from interactive investor

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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.   

Here’s what you need to know this week. 

How will bonds perform over the next decade? 

Via its giant LifeStrategy range, which uses passive funds to give investors balanced exposure to stocks and bonds, fund manager Vanguard is one of the most common ways that UK investors access bond markets. 

Therefore its investment return forecasts are an important indicator of what LifeStrategy investors may make on their investments.  

In its updated outlook for 2024 and beyond, the US fund group said that “bonds are back” and it now expects US bonds to return an annualised 4.8%–5.8% over the next decade, compared with the 1.5%–2.5% it expected before the rate-hiking cycle began in 2021. 

For international bonds, it expects annualised returns of 4.7%–5.7% over the next decade, compared with a forecast of 1.3%–2.3% when rates were low or, in some cases, negative. 

This shows that higher interest rates have provided a fantastic reset for bond investors, and expected returns are now substantially higher than before the rate rising cycle began in late 2021.  

But it is not so positive on equities. Vanguard says that “valuations” are most stretched in the US and as a result it has downgraded its US equity return expectations to an annualised 4.2%–6.2% over the next 10 years, from 4.4%–6.4% heading into 2023. 

This means that bond and equity return expectations are relatively similar, which should bode well for more risk-averse investors who are drawn to LifeStrategy funds with high allocations to bonds.  

How will the UK economy perform in 2024? 

The outlook for the UK economy is closely linked to the outlook for the bond market, with lower inflation and steady economic growth likely to boost bonds, while any indication that interest rates will have to stay high to bring down higher than expected inflation likely to lead to falling bond prices (and therefore higher yields).  

So, what is in store for the economy in 2024? 

Consultancy KPMG reckons that gross domestic product will continue to grow at a modest pace of 0.5% in 2024, and only pick up towards its steady-state rate of around 1% in 2025. 

The chief economist Yael Selfin says that because inflation is now around 4%, the UK is no longer an outlier compared to other major economies.  

“But domestic influences – including a tight labour market, strong services price inflation, and firms passing on higher costs to consumers – continue to keep core inflation elevated,” she adds. 

Therefore, Selfin reckons that the Bank of England will only normalise interest rates when it’s confident that inflation is firmly on target. 

“That’s unlikely to happen before the latter part of 2024,” she said. 

These articles are provided for information purposes only.  Occasionally, an opinion about whether to buy or sell a specific investment may be provided by third parties.  The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.

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