Following one of the worst annual performances on record in 2022, aggregate bond strategies are rebounding this year as fixed income market observers price in reduced interest-rate tightening by the Federal Reserve.
In fact, only three high-yield fixed income segments are outpacing longer-dated bond strategies on a year-to-date basis. Renewed enthusiasm for higher-quality bonds is supporting exchange traded funds such as the Vanguard Total Bond Market ETF (BND). The Vanguard offering follows the Bloomberg U.S. Aggregate Bond Index, which ensures a broad lineup as highlighted by the fact that BND is home to 10,375 bonds, according to issuer data.
Aggregate bond ETFs, including BND, are typically heavy on Treasurys and intermediate to longer duration, levering these funds to Fed policy. That tide could turn in favor of these products in the second half of the year.
“The shift to a more gradual tightening stance reflects growing confidence that policy is succeeding. Economic growth is slowing, and inflation is easing,” according to Charles Schwab research. “Gross domestic product (GDP) growth has averaged less than 1.5% over the past four quarters, the manufacturing sector appears to be in recession, and housing activity has fallen sharply. The service sector has proven more resilient, but the pace of growth is easing.”
BND Bond ETF Could Be Sustainable
BND and its brethren are sure to be in focus in the days ahead. The May reading of the Consumer Price Index (CPI) arrives on June 13, and the Fed commences its June meeting later this week.
With all eyes on inflation and rate policy, the potential benefit to funds such as BND is that the CPI will decline enough that the Fed doesn’t need to raise rates this month. That’s the expectation. While inflation still isn’t in the Fed’s desired range of 2%, there are some green shoots emerging.
“The good news is that the ‘stickiness’ in inflation is now confined to a smaller number of categories compared to earlier in the year,” added Schwab. “In recent months three categories largely accounted for above-average inflation—housing, financial services and used cars. As the categories of price inflation narrow, the overall trend will likely improve.”
Other BND benefits include credit quality and diversification. Some market observers believe now is the time to embrace highly rated bonds, including corporate debt. BND obliges on both fronts.
“With current yields in the region of 4% to 5% for high-credit-quality bonds such as Treasuries, other government-backed bonds, and investment-grade corporate and municipal bonds, we think it makes sense to lock in those cash flows with certainty rather than risk reinvesting maturing short-term bonds into lower yields once the Fed begins to cut interest rates,” concluded Schwab.
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