Some may view fixed income as a safe haven for investors, expecting bonds to rise in value when stocks fall. However, this was not the case in 2022. The tandem decline for equities and fixed income was relatively rare. Benchmark US Treasuries posted their worst annual returns in decades, with 10-year Treasury notes losing 16.3%, a second straight annual loss. The last time investors saw back-to-back losses was in the late 1950s. The yield curve, which charts the difference in yield between long-dated and short-dated bonds, was inverted at year’s end. The 10-year yield ended just below 3.9%, while the 2- year yield was just above 4.4%, reflecting the higher short-term rates.
Higher interest rates can bring short-term pain as bond prices fall, but they can be beneficial in the long term and present new opportunities for fixed income investors. Some investors may be hesitant to take advantage of higher yields, perhaps because of concerns about the potential for even higher yields to come. They may even consider reducing their bond exposure. But if yields keep rising, investors seeking higher expected returns may still be better off maintaining the duration of their fixed income allocation. Rising yields affect fixed income portfolios in several ways. Longer-duration portfolios may experience larger immediate declines in value relative to shorter-duration portfolios as yields increase. But higher yields may lead to higher expected returns. Similarly, investors who have seen equity prices fall may be tempted to sell. But lower stock prices can be indicative of higher expected returns.