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A great time for bonds

Fidelity and PIMCO managers have high expectations for fixed income.

Key takeaways

  • Relatively high yields on investment-grade bonds are reducing risks posed by interest rate uncertainty and creating a favorable environment for investors in the second half of 2024.
  • Higher yields enable individual bonds to once again play their traditional role as sources of reliable, low-risk income for investors who buy and hold them to maturity.
  • Some areas of potential opportunity include investment-grade corporate bonds, mortgage-backed securities, and securities backed by consumer credit cards, auto, and student loans.
  • Bond mutual funds and exchange-traded funds (ETFs) may help investors diversify their bond exposure and target specific goals such as income, yield, or total return.

It's been almost 20 years since bonds presented as attractive an opportunity as they are likely to in the second half of 2024. Economic conditions and changing monetary policy are combining to create an environment where high-quality, low-risk investment-grade bonds can deliver higher interest payments than they have in decades and more potential for capital appreciation than stocks or cash offer. Throw in bonds’ lower volatility than stocks and an increasing tendency to rise when stocks fall, and it’s easy to see why Fidelity and PIMCO bond fund managers believe that fixed income now offers a once-in-a-generation opportunity for new-to-bonds investors to seek reliable income and a chance to help grow their portfolios, and help reduce risk.

To understand the opportunity they see in the second half of 2024, it’s important to first understand where bond returns come from. A bond can deliver return to its owner from 2 sources: interest payments known as coupons, whose rate is set at the time the bond is issued, and changes in the price of the bond as it trades in the market.

The interest rate of the coupon remains the same until the bond matures but the price can rise or fall throughout the trading day. Because bond prices typically rise when interest rates fall, the best way to earn a high total return from a bond or bond fund is to buy it when interest rates are high but about to come down. If you buy bonds toward the end of a period when rates are rising, you can lock in high coupon yields and also enjoy the increase in the market value of your bond once rates start to come down.

Now’s the time

Jeff Moore manages the Fidelity® Investment-Grade Bond Fund (), Fidelity® Investment-Grade Bond ETF (), and Fidelity® Tactical Bond ETF (). He believes that the second half of 2024 is likely to be a time when skilled bond investors will be able to do just that. He says that for the high-quality bonds that his fund buys, average yields are higher than they have been since before the 2008 global financial crisis, which ushered in a long period of near-zero interest rates and bond yields. “Right now, the average yield on the Bloomberg US Aggregate Bond Index is up to around 5%, and the yield for investment-grade corporate bonds is roughly 6%," says Moore. “Those starting yields are a big reason why bonds should deliver attractive total returns during the rest of 2024 and beyond, regardless of where interest rates go. If the Federal Reserve lowers interest rates, which it’s expected to do, the interest payments on those bonds will be supplemented by higher market prices, which could boost the total return of the bonds closer to the average historical return of US stocks. Even if the Fed does something unexpected and leaves rates alone or raises them further, starting coupon yields are high enough to still deliver a positive return to bondholders.”

Moore isn’t alone in believing that the forecast looks bright for bonds in the second half of 2024. David Braun manages the PIMCO Active Bond Exchange-Traded Fund (BOND), which is available commission-free through Fidelity’s FundsNetwork. He agrees with Moore and says, “The all-important starting yields are higher than they’ve been for a long time and interest rates are likely ready to come down, starting in the second half of 2024 and continuing into next year. That’s the combination we’ve been waiting for,” Braun says. “This is perhaps the most excited and bullish I've been on US core bonds in 15 years.”

Why bonds may be better than cash or stocks in the second half of 2024

Moore believes that bonds in the second half of 2024 present a unique and appealing opportunity for investors who have been sitting in money market funds or short-term CDs to not only lock in longer-term coupon income and seek potential capital appreciation, but also to reduce risk in their portfolios. While yields on cash-like assets such as CDs and money markets have risen to roughly 5% since the Fed began raising short-term interest rates in 2022, those yields are likely to move lower in the second half of 2024 and to stay lower than they have been over the past 2 years.

Says Braun, "I think the Fed is likely to cut once…maybe twice…in the latter part of this year. Next year it appears that they are set up to be even more aggressive, ultimately creating a less attractive backdrop for dollars that have been sitting on the sidelines in money markets and CDs.” That raises the risk that investors who need a certain level of income from their portfolios won’t get it if they stay in cash.

While the record-setting performance of the S&P 500 may look like a compelling solution for those who recognize the need to invest their cash, Moore points out that bonds are still relative bargains and may have more room to rise in price in the second half of 2024 than stocks, which have become expensive by historical standards over the past year. So if you are on the sidelines waiting in cash, it may be a good time to take advantage of the opportunities that current high yields are creating in bonds.

Back to normal at last?

According to Moore, bonds should become increasingly able in the second half of 2024 to play their historic role of delivering significant income and also of preserving capital by rising in price when stocks fall. He believes that the Fed holds the key to the return of “normal” bond markets and will be able to both lower interest rates and reduce the size of its balance sheet, which had become bloated as a result of massive purchases of government debt under its policy of “quantitative easing” to stimulate economic growth. That means that willing buyers and willing sellers—rather than government policies—will once again determine prices in financial markets. Since the 2008 financial crisis, the Fed has played an outsized role in markets, which has caused stocks and bonds to move up and down in tandem more than they have historically. “As these policies are wound down, bond markets should start to behave the way they have for most of history, rising when stocks fall and helping investors diversify and reduce risk in their portfolios,” Moore says.

Braun also expects the return of normal markets to benefit bond investors: “As rates follow inflation down and the Fed shrinks its balance sheet, that negative stock and bond correlation should start working again, and therefore the 60/40 allocation that we all grew up with is not dead after all. As the Fed goes back to being more of a referee and less of a player in the capital markets, the negative correlation between stocks and bonds should come back. It was never dead, it's just been distorted by $10 trillion of fiscal and monetary stimulus from Washington,” he says.

Beyond investment-grade bonds

While investment-grade bonds offer low risk and potential for attractive total returns in the second half of 2024, less familiar areas of the market are presenting opportunities for skilled managers to find attractively-priced assets with the potential to rise in price and deliver return to bondholders. While Moore has found opportunities in investment-grade corporate bonds, Braun sees diversified yield sources and attractive return potential in Fannie Mae and Freddie Mac mortgage-backed bonds, non-agency mortgage-backed securities, and securities backed by consumer credit cards, auto, and student loans. “There are tremendous opportunities for active managers in these asset classes in the second half of 2024," Braun says.

Investing in a bond mutual fund or ETF

Buying shares of a bond mutual fund or ETF is an easy way to add a bond position. Bond funds hold a wide range of individual bonds, which makes them an easy way to diversify your holdings even with a small investment.

An actively managed fund also gives you the benefits of professional research. For example, the managers can make decisions about which bonds to buy and sell based on huge volumes of information, including bond prices, the credit quality of the companies and governments that issue them, how sensitive they may be to changes in interest rates, and how much interest they pay.

Not all bond funds or ETFs are actively managed. Investors who seek bond exposure in a fund can also choose among ETFs and index funds that track bond market indexes such as the Bloomberg US Aggregate Bond Index.

Here's more about the difference between investing in bond mutual funds or ETFs and individual bonds.

Investing in individual bonds

If you have enough money and believe you have the time, skill, and will to build and manage your own portfolio, buying individual bonds may be appealing. Unlike investing in a fund, doing it yourself lets you choose specific bonds and hold them until they mature, if you choose. However, you still would face the risks that an issuer might default or call the bonds prior to maturity. This approach requires you to closely monitor the finances of each issuer whose bonds you're considering. You also need enough money to buy a variety of bonds to help diversify away at least some risk. If you are buying individual bonds, Fidelity suggests you consider spreading investment dollars across multiple bond issuers.

Fidelity offers over 100,000 bonds, including US Treasury, corporate, and municipal bonds. Most have mid- to­ high-quality credit ratings that would be appropriate for a core bond portfolio.

Tools and resources for investors looking for individual bonds include:

Personalized management

Separately managed accounts (SMAs) combine the professional management of a mutual fund with some of the customization opportunities of doing it yourself. In an SMA, you invest directly in the individual bonds, but they are managed by professionals who make decisions based on factors such as current market conditions, interest rates, and the financial circumstances of bond issuers. Find out more about separately managed accounts.

Whatever your bond investing goals, professionally managed mutual funds, active ETFs, or separately managed accounts can help you. You can run screens using the Mutual Fund Evaluator and ETF/ETP Screener on Fidelity.com. Here are some ideas as of June 25, 2024:

Bond mutual funds

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

ETFs

  • Fidelity® Total Bond ETF ()
  • Fidelity® Investment Grade Bond ETF ()
  • PIMCO Active Bond Exchange-Traded Fund ()
  • iShares Core US Aggregate Bond ETF ()
  • iShares Core Total USD Bond Market ETF ()

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More to explore

Before investing in any mutual fund or exchange-traded fund, you should consider its investment objectives, risks, charges, and expenses. Contact Fidelity for a prospectus, an offering circular, or, if available, a summary prospectus containing this information. Read it carefully.

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This information is intended to be educational and is not tailored to the investment needs of any specific investor.

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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.

Credit and default risk - While MBS backed by GNMA carry negligible risk of default, there is some default risk for MBS issued by FHLMC and FNMA and an even higher risk of default for securities not backed by any of these agencies, although pooling mortgages helps mitigate some of that risk. Investors considering mortgage-backed securities, particularly those not backed by one of these entities, should carefully examine the characteristics of the underlying mortgage pool (e.g. terms of the mortgages, underwriting standards, etc.). Credit risk of the issuer itself may also be a factor, depending on the legal structure and entity that retains ownership of the underlying mortgages.
 
Interest rate risk - In general, bond prices in the secondary market rise when interest rates fall and vice versa. However, because of prepayment and extension risk , the secondary market price of a mortgage-backed security, particularly a CMO, will sometimes rise less than a typical bond when interest rates decline, but may drop more when interest rates rise. Thus, there may be greater interest rate risk with these securities than with other bonds.
 
Prepayment risk - This is the risk that homeowners will make higher-than-required monthly mortgage payments or pay their mortgages off altogether by refinancing, a risk that increases when interest rates are falling. As these prepayments occur, the amount of principal retained in the bond declines faster than originally projected, shortening the average life of the bond by returning principal prematurely to the bondholder. Because this usually happens when interest rates are low, the reinvestment opportunities can be less attractive. Prepayment risk can be reduced when the investment pools larger numbers of mortgages, since each mortgage prepayment would have a reduced effect on the total pool. Prepayment risk is highly likely in the case of MBS and consequently cash flows can be estimated but are subject to change. Given that, the quoted yield is also an estimate. In the case of CMOs, when prepayments occur more frequently than expected, the average life of a security is shorter than originally estimated. While some CMO tranches are specifically designed to minimize the effects of variable prepayment rates, the average life is always at best, an estimate, contingent on how closely the actual prepayment speeds of the underlying mortgage loans match the assumption.
 
Extension risk - This is the risk that homeowners will decide not to make prepayments on their mortgages to the extent initially expected. This usually occurs when interest rates are rising, which gives homeowners little incentive to refinance their fixed-rate mortgages. This may result in a security that locks up assets for longer than anticipated and delivers a lower than expected coupon, because the amount of principal repayment is reduced. Thus, in a period of rising market interest rates, the price declines of MBS would be accentuated due to the declining coupon.
 
Liquidity - Depending on the issue, the secondary market for MBS are generally liquid, with active trading by dealers and investors. Characteristics and risks of a particular security, such as the presence or lack of GSE backing, may affect its liquidity relative to other mortgage-backed securities. CMOs can be less liquid than other mortgage-backed securities due to the unique characteristics of each tranche. Before purchasing a CMO, investors should possess a high level of expertise to understand the implications of tranche-specification. In addition, investors may receive more or less than the original investment upon selling a CMO.

Investments in mortgage securities are subject to prepayment risk, which can limit the potential for gain during a declining interest rate environment and increase the potential for loss in a rising interest rate environment.

You could lose money by investing in a money market fund. An investment in a money market fund is not a bank account and is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. Before investing, always read a money market fund’s prospectus for policies specific to that fund.

 Any fixed income security sold or redeemed prior to maturity may be subject to a substantial gain or loss. Your ability to sell a CD on the secondary market is subject to market conditions. If your CD has a step rate, the interest rate of your CD may be higher or lower than prevailing market rates. The initial rate on a step rate CD is not the yield to maturity. If your CD has a call provision, which many step rate CDs do, please be aware the decision to call the CD is at the issuer's sole discretion. Also, if the issuer calls the CD, you may be confronted with a less favorable interest rate at which to reinvest your funds. Fidelity makes no judgment as to the credit worthiness of the issuing institution. **$0.00 commission applies to online U.S. equity trades and exchange-traded funds (ETFs) in a Fidelity retail account only for Fidelity Brokerage Services LLC retail clients. A limited number of ETFs are subject to a transaction-based service fee of $100. Sell orders are subject to an activity assessment fee (historically from $0.01 to $0.03 per $1,000 of principal). Other conditions may apply. See full list at Fidelity.com/commissions. Employee equity compensation transactions and accounts managed by advisors or intermediaries through Fidelity Institutional® are subject to different commission schedules.**

Indexes are unmanaged. It is not possible to invest directly in an index.

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

Keep in mind that investing involves risk. The value of your investment will fluctuate over time, and you may gain or lose money.

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