How Bond Investors Should Adjust to a New Era of Volatility

Fixed income—long one of the most stable investment categories—has grown increasingly volatile in the face of geopolitical and economic uncertainty.

High inflation and a string of interest rate hikes across the globe resulted in bruising years for bonds in 2022 and 2023. This occurred as central banks scrambled to stabilize economies amid supply chain disruptions, a war in Europe and rising energy costs.

Against this backdrop, bond yields soared to their highest levels in a decade, resulting in some heavy losses for the asset class.

The exciting news is that the market volatility of the last two years has come with a silver lining. The “income” in “fixed income” is back.

“Fixed income presents more opportunities for investors today than it has for years,” says Kristina Hooper, Invesco’s Chief Global Market Strategist.

Despite the opportunity now available, two important questions remain: What’s next for interest rates, and are global economies heading towards recession? Uncertainty around these questions can leave some investors unsure how to proceed. And timing the market perfectly is almost impossible.

“As the old adage goes, they don’t ring a bell at the top or the bottom of the market,” says Invesco’s Lyndon Man, who is responsible for a number of investment grade credit portfolios.

Being too reactive to certain news events or data releases can also result in investors being either too conservative or too aggressive in their investment decisions.

For example, the collapse of Silicon Valley Bank in March last year and the subsequent merger of UBS and Credit Suisse raised alarms, proclaiming the start of a second 2008 and sending many investors running for cover. But the situation soon stabilized and was largely contained.

The crucial task for investors is to weigh all the key considerations to form an idea of the bigger picture. Which headlines are just short-term noise, and which indications are likely to develop into more meaningful long-term trends?

As part of this process, fixed income investors will continue to keep their eyes glued to the data as it is released. However, the focus should be less on timing the market perfectly than on readjusting assessments of risk and reward as the backdrop evolves.

Invesco’s Man illustrates this point, arguing that even if his team doesn’t time things perfectly, they are still well set up to capitalize on the yield opportunities currently available.

“Could yields go a bit higher from here?” Man asks. “Of course. But, looking at a five- to 10-year time frame, we think there is plenty of cushion from the real yields on offer to absorb some bumps along the way.”

Stuart Edwards, who manages several global and strategic bond portfolios at Invesco, agrees. “Regardless of the exact path of interest rates from here, we believe now is the right time to be increasing duration and reducing credit risk, given the balance of risk and reward.”

While the economy has experienced the most aggressive central bank action in a generation, Edwards says the interest rate environment “gives us a unique opportunity to lock in income for the years to come. But the flipside is that it is creating a more challenging economic environment for businesses.”

Improving the credit quality of portfolios will help mitigate this risk.

“It’s better to be too early than too late,” he says.