Struggling Bond Market Reflects Economic Uncertainty

A key fund that closely tracks the performance of the massive $55 trillion U.S. bond market is on the verge of its lowest close since the financial crisis in 2008.

The recent sharp selloff in the Treasury market, which accounts for roughly $25 trillion, has had a knock-on effect on the broader U.S. bond market valued at $55 trillion. As a result, shares of the iShares Core U.S. Aggregate Bond ETF (AGG) are teetering on the edge of hitting their lowest close since October 2008, according to Dow Jones Market Data.

The fund's shares managed to inch up slightly by less than 0.1% on Thursday, reaching around $93.90 per share as reported by FactSet. This comes after a previous dip to $93.60. If the shares were to close at this level, it would mark the ETF's lowest finish since October 13, 2008, when it concluded at $91.82.

It is crucial to understand the significance of this ETF as it mirrors the U.S. Bloomberg Aggregate Bond Index, the primary benchmark for investment-grade bonds. All fixed-income investors aspire to outperform this index each year.

Mike Sanders, the head of fixed income at Madison Investments, commented on the current state of the bond market, describing it as "edgy." He also noted that the bond market has finally grasped the seriousness of the Federal Reserve's commitment to maintaining higher interest rates.

The Bloomberg "AGG" primarily consists of longer-term bonds, resulting in an index with a duration of six years. Year-to-date, the total return of the index stands at -1.4%, as reported by FactSet. Moreover, it is on track to deliver a three-year return of -15.5%.

The Impact of Rising Interest Rates on Bond Funds

The recent selloff in the bond market has had a particularly noticeable effect on funds that invest in longer-duration bonds. One such example is the popular iShares 20+ Year Treasury Bond ETF (TLT), which has seen an 11.4% decline in value so far this year.

According to Sanders, a manager of the firm's core bond fund and two exchange-traded funds, there is still potential for positive total returns in the intermediate space. This is due to the rise in interest rates at the back-end, despite the significant increase they have experienced.

On the other hand, the front-end Treasury bills have remained relatively steady, with a yield range of around 5.5%. This stability has been maintained even after Fed Chairman Powell's recent announcement sparked a selloff in longer 10-year Treasury securities. Powell indicated that the central bank's policy rate may be cut only two times next year, rather than the previously expected four.

Last week, the Fed also decided to keep its policy rate within a range of 5.25% to 5.5%, which is the highest it has been in 22 years.

Sanders advises against abandoning fixed-income investments at this time, emphasizing that although there has been some pain, it is important to consider the starting point. Even a slight decrease in interest rates can quickly recover the lost performance and provide additional returns.

It is worth noting that bond prices and yields move in opposite directions. While stocks have also faced pressure throughout the week, there has been a slight increase in their values on Thursday. The Dow Jones Industrial Average (DJIA) was up by approximately 200 points or 0.6%. Additionally, the S&P 500 index showed a 1% increase, while the Nasdaq Composite Index rose by 1.3%.