Bond ETFs fall after fresh inflation data (2024)

FAQs

Why are bond ETFs going down? ›

Popular bond ETFs have been hurt by the market moves, as traders pushed out bets for when the Fed may become confident enough that inflation is easing durably toward its target to start cutting rates. Climbing interest rates hurt bond prices, which fall when yields go up.

Bond ETFs are affected by changing interest rates, because of the impact on the bonds in their underlying portfolios. When interest rates decrease, bond prices increase, and when interest rates rise, bond prices decline.

While equity returns outstrip inflation in the long-run, inflation-linked bonds are designed to compensate in the short-term. Moreover, if you hold an inflation-linked ETF for income then you know that your payments will keep up with rising prices. Eurozone linkers are also proof against deflation.

The problem is that over time, inflation will still eat away at the value of that bond. That's especially an issue for long term bonds. TIPS solve for that problem by adjusting the amount due to investors based on changes in the consumer price index. This means that investors get paid more as inflation rises.

Bond ETFs can lose value due to several factors, including changes in interest rates, credit risk, and market sentiment. When interest rates rise, the prices of existing bonds, which have lower interest rates compared to new bonds, tend to fall. Since a bond ETF holds many such bonds, its value can decrease as well.

As inflation finally seems to be coming under control, and growth is slowing as the global economy feels the full impact of higher interest rates, 2024 could be a compelling year for bonds.

In other words, bond ETFs are at risk if the borrower defaults as this means they may not pay the entire amount of the bond back. While there is no debt to an equity ETF, the underlying companies can still incur losses and lose value.

The table on the right shows that bond prices often recover within 8 to 12 months. Unnerved investors that are selling their bond funds risk missing out when bond returns recover. It is important to acknowledge that some of those strong recoveries were helped by bond yields that were higher than they are today.

When you buy a bond, you are essentially lending the government or company money which they promise to repay after a set period of time, often with a set amount of interest or income. Inflation tends to be bad news for bonds because it eats into the future buying power of the fixed income they provide.

Should I invest in bonds when inflation is high? ›

Bond prices are inversely rated to interest rates. Inflation causes interest rates to rise, leading to a decrease in value of existing bonds. During times of high inflation, bonds yielding fixed interest rates tend to be less attractive.

I bonds protect you from inflation because when inflation increases, the combined rate increases. Because inflation can go up or down, we can have deflation (the opposite of inflation). Deflation can bring the combined rate down below the fixed rate (as long as the fixed rate itself is not zero).

The “T-bill and chill” strategy might pay off over some shorter-term periods (as it has over the past 12 months), but it's not a reliable way to build long-term wealth.

As you can see, the 2023 yields were about 30 basis points higher than today's elevated levels. October 2023 was a great month for building a ladder of TIPS investments, with all maturities yielding close to 2.5% above inflation. April 2024, in fact, is also an opportune time for making new TIPS investments.

The reason has to do with the relative value of the interest that a specific bond pays. Rising prices over time reduce the purchasing power of each interest payment a bond makes. Let's say a five-year bond pays $400 every six months. Inflation means that $400 will buy less five years from now.

Most bonds pay a fixed interest rate that becomes more attractive if interest rates fall, driving up demand and the price of the bond. Conversely, if interest rates rise, investors will no longer prefer the lower fixed interest rate paid by a bond, resulting in a decline in its price.

We expect bond yields to decline in line with falling inflation and slower economic growth, but uncertainty about the Federal Reserve's policy moves will likely be a source of volatility. Nonetheless, we are optimistic that fixed income will deliver positive returns in 2024.

If prevailing interest rates increase above the bond's coupon rate, the bond becomes less attractive. In this situation, the bond price drops to compensate for the less attractive yield.