Bonds are becoming interesting again

Many investors had lost confidence in bonds as an investment category in recent years. Now that interest rates are higher again, bonds are once again coming back into the picture. To understand this shift, it is helpful to take a brief look at the evolution of the bond market.

The extremely high interest rates observed at the beginning of the 1980s marked the start of a forty-year bull market for bonds, during which prices rose. A high initial interest rate followed by falling interest rates in an environment of decreasing inflation proved favourable for bond yields.

After the global financial crisis, long-term interest rates remained exceptionally low for years, and in the panic surrounding the pandemic, some interest rates even fell below 0%.

The interest rate trend reversed afterwards, with extensive government spending, disruptions in supply chains and higher inflation accompanied by tighter monetary policy from central banks. The rising interest rates led to significant price losses on the bond market.

Table 1 illustrates the declining returns on investments in US government bonds over the last three decades. European government bonds also experienced a similar trend on their returns.

Table 1: Returns on bond investments per decade

Source: The Compound

Now, the bond market finds itself in a different interest rate environment. As shown in Graph 1, long-term interest rates have risen sharply worldwide.

Graph 1: Global development in long-term interest rates

Source: All Star Charts

At the current interest rates, bonds can once again play an interesting role in a diversified portfolio. They can help to absorb stock market corrections and limit fluctuations in the portfolio. Investors can also hold part of their assets in bonds, allowing them to take advantage of new investment opportunities at a later date if the stock market enters a sharp decline.

The term also remains an important point to consider, and indicates how sensitive a bond price is to changes in the market interest rate. The longer the term, the more strongly the price reacts to a change in the interest rate.

The term acts as a rough guide for how much the price changes when the interest rate rises or falls by one percentage point. A term of five, for instance, indicates that an interest rate rise of one percentage point will lead to a price drop of around 5%. Bond prices and market interest rates move in opposite directions.

Rising interest rates are therefore making bonds attractive again, while their interest rate sensitivity necessitates continued attention. The Keytrade Bank platform offers actively managed bond funds and passive trackers that track long-term government bonds and more.