What is happening to bonds?

Chris Beauchamp, chief market strategist at IG Group, says the other reason investors have started to look again at bonds is that, in the event of a recession next year, investors would likely flock to bonds as a safe haven, causing prices to rise. 

His current base case is that an economic downturn will happen, but that it will lead to a sharp decline in inflation, both of which would boost the investment case for bonds. 

Brady says “there is a clear path” to inflation falling to 4 per cent over the coming year, though he does not feel it will drop to central bank target levels of 2 per cent. 

Sajiv Vaid, a fixed income fund manager at Fidelity, says: “People want to own bonds as a diversifier away from equities, and to be paid an income. We had probably a decade where neither of those things were really available from bonds, but that has changed.

"In a benign economic environment, where things are neither too hot nor too cold, the bulk of the returns from bonds came from just clipping the coupon (collecting the income), but in the sort of environment we are likely to get now, some [of the returns will come from] capital gains from the bonds as well."

High-yield bond investors will have a more volatile journey but you will be rewarded for that. And good credit selection can mitigate risk.Stephen Snowden, Artemis

He is another investor who feels that inflation will decline next year. 

Vaid says: “Inflation is a lagging indicator. The inflation we are experiencing now is a consequence of the pandemic, it is no surprise. But market expectations now are for inflation to be much lower next year. I think, on a total return basis, bond investors should expect low double digit returns next year.” 

Although he agrees that inflation is likely to be much lower next year, Beauchamp’s view is that 2022’s inflation has been the consequence of higher levels of demand in the economy, with the inflation of 2021 caused by the pandemic.  

Stephen Hayde, who runs the Discretionary Diversified Income Portfolio Fund at Close Brothers Asset Management, says: “High inflation now is just a single point in time. Most investments have long-term investment horizons, so the more important question is what inflation will be over that time horizon.

"Interestingly towards the end of 2021, when asset valuations got really expensive, we were selling bonds when the average BBB yield was just 2 per cent, yet today the average BBB yield is over 6 per cent.

"Despite this the 10-year break-even rate (a proxy for long-term inflation expectations) is the same today as it was back then (c3.8 per cent), so the outlook for both nominal and real returns has much improved.”