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Bonds market outlook

The most up-to-date information on the bonds market outlook.

Last updated 20 October 2022


The market outlook for bonds today and into 2023

An historically bad first half of 2022 for the bond market means that there could be an opportunity for investors seeking high yields and the chance of capital gains. Bond prices and yields have an inverse relationship. Because bond prices are at a low, this means yields are at a high. 

Fund managers, including Vanguard and Schroders, have declared that higher yields mean “bonds are back” as investors can receive an inflation-beating income based on price-rise forecasts for the next five years. 

For the past couple of years, bond yields have been at historically low levels. That’s because of a decade of so-called quantitative easing, or QE – a bond-buying programme used by central banks to support the global economy. 

However, the outlook is uncertain because of deteriorating economic conditions in Europe, Britain and America which can impact demand for bonds. 

What events impact the bond market? 

Interest rates

The big factor that impacts bond prices is interest rates. This risk-free borrowing rate is set by each country’s central bank. When rates go up, it means that investors can get a better deal from newly issued bonds, and therefore they sell old bonds to lock in a better rate from a new bond.
When rates go down, this has the opposite effect. The old bonds that have higher interest rates become more valuable.

Economic growth and stability

Economic growth and the possibility that companies cannot pay back the interest on their bonds is another important factor for the bond market. While there is next to no chance that safe governments will stop paying interest, and very little chance that blue-chip firms will default on their debt, even during a recession, the same is not true for the riskier end of the bond market, so-called high yield, or “junk” bonds. 


Inflation is also a consideration. Because bonds pay a fixed income, the real value of that income is eroded when inflation is high.

What will happen to interest rates?

The primary job of central banks is to use interest rates to influence the economy, with the UK, US and Europe normally targeting 2% inflation. 

When the economy overheats and prices start to rise, or look like they might, interest rates should rise. This has the effect of decreasing economic demand and slowing down price rises. When the economy needs an extra boost, cutting rates should boost economic activity. 

Everything hinges on inflation, which is closely linked to energy prices and government policies. 

What does the high inflation environment mean for bonds?

Bonds do not like inflation. Not only does it decrease the real value of the fixed income they pay, but it pushes central banks to raise interest rates, which is bad for bond prices. 

Unlike with stocks and shares, any benefits of inflation, such as higher profits, are not felt by bond investors.

However, over the long term, rising interest rates can actually increase a bond fund’s return as the money from maturing bonds is reinvested in bonds with higher yields. 

Whereas, when interest rates are falling, money from maturing bonds may need to be reinvested in new bonds that pay lower rates, potentially lowering longer-term returns.

Another factor to watch is corporate profits, which are affected by inflation, and the possibility that companies cannot pay back the interest on their bonds. 

Safe governments will not stop paying interest, and there’s very little chance that blue-chip firms will default on their debt, even during a recession. However, the riskier end of the bond market - high yield or junk bonds – carries a much greater possibility of default.  

Investors and economists are trying to figure out how high inflation will go. Given most of the inflation is driven by higher food and energy prices, there is a limit to inflation measured on a year- over-year basis.

Oil and gas prices are highly unlikely to keep rising after their historic spike this year and “lap” the record prices set already. Eventually, therefore, year-over-year comparisons could begin to look favourable. This is known as the “base effect”. 

The big question about high inflation and how long it will last comes down to wages, and how quickly they rise. So far, wages have not kept pace with inflation, as they did in the 1970s, but if employees are able to secure wages that match inflation, then it could spark a wage-price spiral where prices and wages keep rising, leading to persistently high inflation. 

Bonds outlook by type 

Long term bonds

Short term bonds

Long-term bond outlook

Bonds with the longest maturity dates, such as those with 20 or 30-year lifespans, are most sensitive to interest rate changes. 

Known as long “duration” assets, investors committing to lend money for a long period at a fixed interest rate suffer more when interest rates rise, which give investors a better deal on newly issued bonds. 

This means that if inflation rises more than expected, therefore increasing expectations for more rate rises, long-term bonds will fall the most.

Longer bonds tend to offer higher yields than shorter dated bonds to compensate investors for locking up their money for longer periods. 

However, sometimes shorter bonds have higher yields. This causes what’s called an inversion in the yield curve, a graph which plots the yields of different maturity bonds.

This happens when investors are worried about the future and therefore demand a greater return on their cash. 

Short-term bond outlook 

One way of limiting interest rate risk is to buy bonds that are “short duration”, meaning that they are about to mature. 

These bonds are less impacted by changes in interest rates. The trade-off is that the yields are normally lower than bonds with longer lifespans. 

Short-term bonds are one of the safest parts of the bond market, especially if the bonds are issued by financially secure companies or governments. 

Bonds outlook by category 

Corporate bonds

Government bonds

Corporate bonds

Bonds issued by companies are called corporate bonds. They have different maturity lengths and credit scores, with the riskiest bonds being “high yield” and the safest being “investment grade”. 

A way of safeguarding against interest rate rises is to buy “high yield” bonds, which offer higher yields but are riskier because the companies issuing the debt are less financially secure than the safest “investment grade” bonds.

Their prices are tied to the health of the economy. A more positive economic outlook is seen as good for high yield bonds because they are less likely to default. A slowdown in growth, however, is bad for high-yield bonds. 

Vanguard, the fund manager, says that following the rise in bond yields in 2022 corporate bonds are good value. Investment grade bonds are more sensitive to changes in interest rates, with longer-dated bonds being the most sensitive. However, default rates are much lower for investment grade bonds, meaning that income payments are more secure than high yield as we head into an economic downturn. 

Government bond outlook

Not all government bonds carry the same risk. Bonds from emerging markets, such as Argentina or Russia, are considered higher risk as there is a greater chance that the government will not pay the interest payments or return the principal. 

Economic crises in parts of the emerging world due to higher food prices and the effects of climate change, such as in Sri Lanka or Pakistan, are fuelling a negative outlook for emerging market bonds.

Meanwhile, ‘developed world’ government bonds, such as those from Britain or the United States, are considered extremely safe and carry little to no risk of investors not being paid interest. The risk, however, is that interest rates rise, which makes existing bonds less valuable. This is what is causing US and UK government bond prices to fall in value in 2022. 

During times of economic stress, safer government bonds tend to rise in value. However, if interest rates are rising, that will tend to cancel out the benefits of securing a stable income. 
One key consideration when buying bonds is currency risk. If an investor owns bonds that are priced in euros or US dollars, and pay income in those currencies, then their actual return is affected by exchange rate fluctuations.

This is particularly important when owning emerging market bond funds, where currencies can be extremely volatile. Emerging markets sometimes issue bonds in “hard” currency, such as US dollars, or in their local currency.

Emerging market bonds issued in dollars carry greater default risk, however. If a government is struggling, it may be challenging for them to find dollars to pay investors. However, paying investors in their own currencies can be done by simply printing more money.


Is now a good time to invest in bonds?

The outlook for the bond market is heavily reliant on inflation, economic growth and interest rates. These three elements are impossible to predict with any certainty, and therefore no one really knows if bond prices will rise or fall. 
However, the bond sell-off in 2022 mean that yields – which move inversely to price – are now at their highest levels for about a decade. 

Will bonds go up if interest rates rise further?

Bond prices move inversely to interest rates. When rates go up, bond prices tend to go down, and vice versa. This is because when interest rates rise, investors can lock in a better return by buying new bonds. This decreases the appeal of older bonds. 

Therefore, if interest rates rise further, this could be bad for bonds. However, it isn’t as simple as that. Markets are forward-looking and attempt to price in what governments and economies will do in the future.

Should I think about selling my bonds?

Bonds serve two roles in a portfolio. The first is for income, which is generated by lending money to governments and companies. The other is to act as a balance to stocks, as bond prices normally rise when stock prices fall. 

Now that yields have risen, the income bonds offer has become more attractive. 

As for what bond prices may do, this all depends on economic data and what central banks decide to do. However, given the bond sell-off in 2022 has been one for the history books, a lot of bad news is already priced into bond valuations and bonds are now far cheaper than a year ago. 

How to buy bonds

You can trade a number of bonds and gilts via your online ii account. For any that aren't available online, you can deal over the phone by calling us on 0345 607 6001.

The value of your investments may go down as well as up. You may not get back all the money that you invest. If you are unsure about the suitability of an investment product or service, you should seek advice from an authorised financial advisor.