One of the biggest surprises of 2023 has been the resilience of the economy and inflation despite the Fed embarking on the most aggressive rate hike campaign in decades. For fixed income investors, it’s been a challenging environment. 

Inflows have been strong and sustained given higher rates and expectations that a recession was imminent. Yet, returns have been mixed especially with there being no change in the Fed’s stance despite some encouraging data on the inflation and economic fronts. Specifically, shorter duration bonds have outperformed, while longer duration bonds have underperformed.

According to Vanguard, it’s simply a case of short-term pain equating to longer-term gains. The selloff in fixed income will lead to higher returns over the intermediate and long-term while generating decent income for investors. Ironically, it’s an inverse of what we experienced over the past decade when bonds were in a decade-plus bull market due to the Fed’s dovish policies. In this environment, there was no value and limited income opportunities in the asset class. 

The firm recommends that investors have exposure to a mix of short and long-duration bonds. The factors that resulted in shorter duration outperformance are unlikely to continue especially given that the labor market is rapidly cooling and yields are at historically attractive levels. 

Finsum: Fixed income has been particularly challenging in 2023 due to the Fed continuing to hike rates. Here are Vanguard’s thoughts on how to navigate the market.