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Bond market outlook

Key takeaways

  • Mutual funds that hold intermediate-term, investment-grade bonds could benefit from the end of interest rate increases by the Federal Reserve.
  • Yields on high-quality bonds have risen back to around their historically normal levels.
  • Higher yields enable bonds to once again play their traditional role as sources of reliable, low-risk income for investors who buy and hold them to maturity.
  • Professional investment managers have the research, resources, and investment expertise necessary to identify these opportunities and help manage the risks associated with buying and selling bonds when interest rates are likely to change.

For bond investors, 2023 was one long Groundhog Day. As the year began, the investment-grade bond market poked its head out of the burrow where it had hibernated since interest rates fell to near zero in 2020. What it saw looked like the end of the Federal Reserve’s interest-rate increases and the deep freeze during which investment-grade bonds lost value for an unprecedented 2 years in a row.

Instead, the Fed spent the year raising rates, pausing, then raising again and the market resumed its nap. Those higher rates lifted the coupon yields that bonds pay to investors but they hurt prices, which are also part of a bond’s total return. Indeed, as 2023 ended, the Bloomberg Barclays Aggregate Bond Index, which represents the vast, investible universe of US bonds, was roughly in the same place it was in when the year started.

Jeff Moore manages the Fidelity® Investment-Grade Bond Fund (FBNDX) and he believes that 2024 will be what others expected 2023 to be for investment-grade bonds: The start of a new era of opportunity for investors who previously felt they had little choice but to either brave the volatility of stocks, or to hide in cash and let inflation rob them of their savings.

Moore believes the Fed’s campaign of raising rates to battle inflation is mostly over and that the central bank has achieved what it set out to do. Now, he says, "Because of the Fed's interest-rate policies, I believe bonds can once again do what they have historically done: Deliver income while helping protect the value of investors’ portfolios from the ups and downs of the stock market."

If you are looking for reliable income, now can be a good time to consider investment-grade bonds. If are you looking to diversify your portfolio, consider a medium-term investment-grade bond fund which could benefit if and when the Fed pivots from raising interest rates. Says Moore: “I think the next 2 years could be a high total return environment for bonds.”

It's all about the Fed

Because bond prices typically fall when interest rates rise, bond markets have long been sensitive to changes in rates by central banks. But they are also influenced by other factors such as the health of the economy and that of the companies and governments that issue bonds. Since the global financial crisis, though, the interest rate and asset purchase policies of the Fed and other central banks have become by far the most important forces acting upon the world's bond markets. In 2022, the focus of their policies shifted from supporting markets to trying to fight inflation, and bond markets have reacted badly as the battle against inflation has continued longer than initially expected.

The Fed's rate hikes ended the bull market in bond prices that had run since 1982. But Moore thinks a new bull may be on the horizon. He says, "Interest rates are now back to almost 30-year norms. Whether you want to build a portfolio with Treasury, municipal, investment-grade corporate, or high-yield bonds, you can get respectable yield and you could do well as rates plateau. You could do even better when interest rates head back down again.”

Moore says the actions of the Fed matter far more for bond prices than worries about rising credit delinquencies, the inversion of yield curves (when short-term bonds pay more interest than long-term ones), or the possibility that foreign governments will stop buying US government bonds. “All of those things can vex the markets, but what really matters is whether the Fed has stopped raising rates,” he says.

Moore says that while the Fed doesn't want to raise—or cut—rates, “If we get some really low inflation, they’re going to have to move quickly to start cutting because the Fed doesn't want to get caught up in the election cycle. That means they’d need to cut before June.”

A recession-ready investment

If the Federal Reserve doesn’t manage to engineer a soft landing for the economy in 2024, bonds may offer investors an attractive strategy for helping manage through a potential recession.

Recessions are times when economic activity contracts, corporate profits decline, unemployment rises, and credit for businesses and consumers becomes scarce. Recessions are not happy times for investors. During the 11 recessions the US has endured since 1950, stocks have historically fallen an average of 15% a year.1

But bonds have historically thrived when the economy has contracted. In every recession since 1950, bonds have delivered higher returns than stocks and cash. That's partly because the Federal Reserve and other central banks have often cut interest rates in hopes of stimulating economic activity during a recession. Rate cuts typically cause bond yields to fall and bond prices to rise.

For investors in or nearing retirement who want to reduce their exposure to stock market volatility, the period before a recession may be a good time to consider shifting some money from stocks to bonds. That's because the Fed is typically raising interest rates to slow growth, which means lower bond prices and higher yields.

Keep in mind, though, that the bond universe is a far more vast and variegated place than the stock market and not all bonds perform equally well during recessions. Investment-grade corporate bonds and government bonds such as US Treasurys have historically delivered higher returns during recessions than high-yield corporate bonds, and Treasurys could outperform corporate bonds in a recession. Moore expects that prices of high-quality corporate bonds will recover strongly once the economy and inflation slow, and the Fed begins cutting rates to stimulate growth.

What about volatility?

Investors who have looked to bonds as safe places to preserve their savings have found their faith tested by the volatility of the past 2 years. Moore points out, though, that during 2021 and 2022, which he calls the worst market conditions in 50 years, bonds still declined much less than did the stocks of the S&P 500 which experienced a bear market that was not particularly severe by historical standards.

Like stocks, bonds are constantly being bought and sold by investors ranging from governments to your neighbors. That means their prices rise and fall over time. Unlike stocks, however, would-be bond investors who are uncomfortable with the idea that prices rise and fall much like an ocean tide can opt to instead purchase individual bonds rather than shares of bond mutual funds or ETFs.

A popular way to hold individual bonds is by building a portfolio of bonds with various maturities: This is called a bond ladder. Ladders can help create predictable streams of income, reduce exposure to volatile stocks, and manage some potential risks from changing interest rates.

The Federal Reserve is expected to stop raising and potentially even lower rates if the economy weakens. A ladder may be useful when yields and interest rates are increasing because it regularly frees up part of your portfolio so you can take advantage of new, higher rates in the future. At the same time, when rates begin to fall, a bond ladder structure can ensure that at least part of your bond portfolio is maintained at the higher yields that prevailed when you had originally invested in the ladder. If all your money is invested in bonds that mature on the same date, they might mature before rates rise or after they have begun to fall, limiting your options.

By contrast, bonds in a ladder mature at various times in the future, which enables you to reinvest money at various times and in various ways, depending on where opportunities may exist.

More fun for funds

While it may be a great time to buy, hold, and ladder bonds, the outlook is also bright for investors in funds that manage bonds with an eye to making money as prices rise. Funds offer a way for investors with fewer assets to get exposure to bonds even if they cannot afford to build a ladder of individual bonds. Moore says he has bought more bonds with longer maturities. “I have bought 10-year Treasury bonds and 10-year bonds from good quality companies because they were yielding 4.25% to 7%. Even if you feel like there's a recession coming, these should be fine.”

Moore believes that market conditions now are similar to 2019 when bond indexes returned almost 10% after a big drop in 2018. “As we approach the end of the Fed’s tightening cycle, there are scenarios where things could go very well. If you just want to build a bond ladder for reliable income, that’s great, but if you care about capital appreciation, you could be kicking yourself for overlooking bond funds if they deliver double-digit return in the next 1 or 2 years.”

Finding ideas

If you’re interested in adding bonds to your portfolio, you can choose from individual bonds, bond mutual funds, and exchange-traded funds as well as separately managed accounts (SMAs).

For retirees and other income seekers who are willing to hold individual bonds to maturity, rising rates can be a good thing. For the first time in decades, it’s now possible to generate a reliable flow of income by arranging low-risk, high-quality bonds of varying maturities in a ladder.

If you're considering individual bonds, you should know that the bond market is large and diverse and getting the best prices can be tricky. Fidelity can help by offering a wide range of ways to research bonds as well as professional help to construct a portfolio that reflects your needs, your tolerance for risk, and your time horizons.

Funds and ETFs offer exposure to the ups and downs of markets where prices change on a daily basis. When interest rates rise, bond fund and ETF prices tend to fall. But when interest rates begin to fall and bond prices rise, bond fund and ETF holders have the potential to benefit.

There are a wide variety of funds and ETFs to choose from, depending on your time horizon and goals. But if you are looking for a high-quality intermediate-term fund, here are some ideas from the Fidelity Mutual Fund Evaluator, as of December 15, 2023.

Intermediate bond mutual funds

  • Fidelity® Total Bond Fund ()
  • Fidelity® Intermediate Bond Fund ()
  • Fidelity® Investment Grade Bond Fund ()


  • Fidelity® Total Bond ETF (FBND)
  • Fidelity® Corporate Bond ETF (FCOR)
  • iShares Core US Aggregate Bond ETF (AGG)
  • iShares Core Total USD Bond Market ETF (IUSB)

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Past performance is no guarantee of future results.

A bond ladder, depending on the types and amount of securities within it, may not ensure adequate diversification of your investment portfolio. While diversification does not ensure a profit or guarantee against loss, a lack of diversification may result in heightened volatility of your portfolio value. You must perform your own evaluation as to whether a bond ladder and the securities held within it are consistent with your investment objectives, risk tolerance, and financial circumstances. To learn more about diversification and its effects on your portfolio, contact a representative. The Bloomberg Barclays US Aggregate Bond Index is a broad-based flagship benchmark that measures the investment grade, US dollar-denominated, fixed-rate taxable bond market. The index includes Treasuries, government-related and corporate securities, mortgage-back securities (agency fixed-rate pass-throughs), asset-backed securities and collateralised mortgage-backed securities (agency and non-agency). The S&P 500® Index is a market capitalization-weighted index of 500 common stocks chosen for market size, liquidity, and industry group representation to represent US equity performance.

In general, the bond market is volatile, and fixed income securities carry interest rate risk. (As interest rates rise, bond prices usually fall, and vice versa. This effect is usually more pronounced for longer-term securities.) Fixed income securities also carry inflation risk, liquidity risk, call risk, and credit and default risks for both issuers and counterparties. Unlike individual bonds, most bond funds do not have a maturity date, so holding them until maturity to avoid losses caused by price volatility is not possible. Any fixed income security sold or redeemed prior to maturity may be subject to loss.

High-yield/non-investment-grade bonds involve greater price volatility and risk of default than investment-grade bonds.

Lower yields - Treasury securities typically pay less interest than other securities in exchange for lower default or credit risk.

Interest rate risk - Treasuries are susceptible to fluctuations in interest rates, with the degree of volatility increasing with the amount of time until maturity. As rates rise, prices will typically decline.

Call risk - Some Treasury securities carry call provisions that allow the bonds to be retired prior to stated maturity. This typically occurs when rates fall.

Inflation risk - With relatively low yields, income produced by Treasuries may be lower than the rate of inflation. This does not apply to TIPS, which are inflation protected.

Credit or default risk - Investors need to be aware that all bonds have the risk of default. Investors should monitor current events, as well as the ratio of national debt to gross domestic product, Treasury yields, credit ratings, and the weaknesses of the dollar for signs that default risk may be rising.

Exchange-traded products (ETPs) are subject to market volatility and the risks of their underlying securities, which may include the risks associated with investing in smaller companies, foreign securities, commodities, and fixed income investments. Foreign securities are subject to interest rate, currency exchange rate, economic, and political risks, all of which are magnified in emerging markets. ETPs that target a small universe of securities, such as a specific region or market sector, are generally subject to greater market volatility, as well as to the specific risks associated with that sector, region, or other focus. ETPs that use derivatives, leverage, or complex investment strategies are subject to additional risks. The return of an index ETP is usually different from that of the index it tracks because of fees, expenses, and tracking error. An ETP may trade at a premium or discount to its net asset value (NAV) (or indicative value in the case of exchange-traded notes). The degree of liquidity can vary significantly from one ETP to another and losses may be magnified if no liquid market exists for the ETP's shares when attempting to sell them. Each ETP has a unique risk profile, detailed in its prospectus, offering circular, or similar material, which should be considered carefully when making investment decisions.

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Diversification and asset allocation do not ensure a profit or guarantee against loss.

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