December 15, 2023

What’s next for bonds?

By Anthony Walters

  • Best month for Bonds since 1985
  • Market says rate cuts ahead; Central Banks pause for thought
  • CleverEngine recognises shift in sentiment and Bond yields

US government bonds have had their best return since the global financial crisis, as markets become increasingly confident that interest rates have hit their peak. A key index tracking total returns on US bonds rose by 4.30% in November, the biggest monthly gain since 1985. In fact, the news was better still for long duration bonds as the iShares 20+ Year Treasury Bond ETF (TLT) returned a total of 6.10% in November. 

Good news: Yields are falling

Bond values and yields have an inverse relationship: when one goes up, the other goes down. Investors who buy bonds receive two types of returns: the interest payments (or yields) and the changes in the bond prices (or capital values). Therefore, if investors want to benefit from higher bond values, they need to accept lower yields, and vice versa.

Since October, yields on 2-Year US treasuries have reduced from 5.14% to 4.70%, which is good news for bond values (figure 1).

Figure 1. 2-year US Treasury yield, Year to Date

Why are yields falling? 

As a caveat, we saw a similar move earlier this year when in March, yields fell dramatically as a result of the short-lived regional banking crisis in the US. However, the driver behind the latest fall in yields is different from the last, as the market continues to price in better than expected inflation data. It is this data that gives hope to the notion of the Federal Reserve (and other central banks) not needing to increase rates but to cut them instead. This is good news for both the economy and bond values, as the cost of borrowing is set to decline. The importance of the 2-Year US Treasury can be noted in its discounting (or forward looking) function.  

As shown in 2019 (figure 2), when the 2-Year Treasury yield falls below the Fed Funds (interest) rate, the rate typically follows suit. This year, a similar scenario has developed where the 2-Year Treasury yield is now below the interest rate, meaning that the market is expecting the Federal Reserve to cut rates in 2024. 

Figure 2. 2-year US Treasury yield and US Federal Reserve target interest rate

Again, that is good news for bond values, particularly the value of longer duration bonds, which are inherently more interest rate sensitive.  

In simple terms, the more that interest rates are cut, the bigger the increase in the capital value of bonds as outlined in figure 3.  

Figure 3. 

What do the central banks say? 

The minutes of the latest Federal Open Market Committee meeting, reflected unanimity among members that monetary policy must remain restrictive “for some time” until inflation is clearly moving toward the Federal Reserve’s 2% goal. Furthermore, US Federal Reserve Chair, Jay Powell said last week that “It would be premature to conclude with confidence that we have achieved a sufficiently restrictive stance, or to speculate on when policy might ease. We are prepared to tighten policy further if it becomes appropriate to do so”. 

In summary, the minutes pointed to a pause in interest rates whilst Chair Powell reminded markets that the Fed stands ready to act if inflation becomes a persistent problem. 

EU and UK central banking guidance is broadly similar whilst the Bank of England cautioned that markets are underestimating the disinflationary challenge ahead. 

The EU recently stated that despite the fall in inflation to 2.40%, the “last mile” of disinflation could be more difficult and take twice as long as getting back under 3%.  

Whilst UK inflation has fallen to 4.60%, Bank of England Governor, Andrew Bailey, told the Treasury Committee that it could take some time before the Bank’s target of 2% was hit. “We are concerned about the potential persistence of inflation as we go through the remainder of the journey down to 2%, and I think the market is underestimating that,” he said. 

The market does say otherwise 

Market odds for a Federal Reserve (Fed) rate cut as soon as March 2024, have risen to 44.50%, according to the CME Group’s FedWatch tool. Odds for a rate cut by May also increased to 77.10%. 

In addition, the Federal Reserve have cut interest rates six months after a pause, as illustrated in Figure 4. 

Figure 4. What happens when the Fed pauses interest rates 

Clever summary 

As the economy slows (to curb inflation), there is a point at which the central banks will undoubtedly act to boost growth. Accordingly, and despite the strong rhetoric from central banks, interest rates will eventually be cut. Although central bankers are urging caution, the market is forecasting that economic data will necessitate a cut in interest rates in the next six months. 

It is the shift in sentiment, coupled with the recent move in Treasury yields that has led to the CleverEngine repositioning some bond holdings and increasing duration. Short Duration bond are a valuable vehicle, although the CleverEngine has recognised that there is the potential for increased upside return capture in bonds with longer duration.

US Treasuries have best month since financial crash – FTAdviser, by Imogen Tew, 05/12/23
Bank of England governor says don’t underestimate inflation – BBC News by
By Dharshini David & Sam Gruet, 21/11/2023
US bonds on track for best month in nearly 40 years (, by Jennifer Hughes, Kate Duguid and Harriet Clarfelt, 29/11/2023
US bonds surge toward their best month since 1985, putting them in positive territory for the year ( by Filip De Mott, 30/11/2023
Fed Minutes Show Consensus: Rates Need to Stay High – Barron’s (, by Megan Leonhardt, 21/11/2023
The last mile (, Isabel Schabel, 02/11/2023

Important Information: This document is a general communication being provided for informational purposes only. It is educational in nature and not designed to be taken as advice or a recommendation for any specific investment product, strategy, plan feature or other purpose in any jurisdiction, nor is it a commitment from Clever to participate in any of the transactions mentioned herein. Any examples used are generic, hypothetical and for illustration purposes only.

This material does not contain sufficient information to support an investment decision and it should not be relied upon by you in evaluating the merits of investing in any securities or products. You should make an independent assessment of the legal, regulatory, tax, credit, and accounting implications and determine – together with your own professional advisers if appropriate – if any investment mentioned herein is believed to be suitable. Investors should ensure that they obtain all available relevant information before making any investment. Any forecasts, figures, opinions or investment techniques and strategies set out are for information purposes only, based on certain assumptions and current market conditions and are subject to change without prior notice.

All information presented herein is considered to be accurate at the time of production, but no warranty of accuracy is given and no liability in respect of any error or omission is accepted. Issued by Clever Adviser Technology Ltd (Clever), a company registered in England and Wales (company number: 2910523) with registered office at Watergate House, 85 Watergate Street, Chester, Cheshire CH1 2LF.


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Anthony Walters

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