Bonds are back, and higher rates are the 'single best development' for investors in the last 20 years, Vanguard says

• Vanguard says bonds are back, thanks to tighter Fed policy.
• Strategists at the asset manager said rising interest rates are a good thing for bond investors.
• "Rather than a bane, the rise in interest rates is the single best development for bond investors in 20 years."

After two years of negative total returns, bonds are back — and investors can thank the Federal Reserve, according to Vanguard. 

"Short-term pain can lead to long-term gain," Vanguard strategists said in a Wednesday note. 

Markets increasingly believe the central bank is done with its historic rate-hiking cycle, and that rate cuts are imminent. Vanguard, for its part, expects policy easing to begin in the second half of the year. 

In any case, higher interest payments have offset declines in bond prices and raised expected total returns over the long term, in the firm's view. Vanguard said reinvestments and new money flowing into fixed income look attractively valued.

"[C]entral banks' unwinding of their bond-buying programs could reduce liquidity and raise the risk premium (investors' requirement for higher yield as compensation for the risk of interest rate changes over a bond's lifetime)," they added.

Vanguard's proprietary models suggest Treasurys are close to fair value based on current fundamentals, which wasn't the case two years ago. 

Based on the chart below, a hypothetical investor who put a lump sum in a bond portfolio in 2021, similar to the Bloomberg US Aggregate Bond Index, for example, would have seen sharp declines in 2022.

The model shows that the portfolio would "break-even" in 2030 in a situation where interest rates stayed low and bond prices didn't fall. 

However, investing new money would mean that break-even point comes much sooner. 

"If anything, bonds at the long end of the maturity spectrum may be somewhat undervalued," strategists maintained. "The bottom line: Rather than a bane, the rise in interest rates is the single best development for bond investors in 20 years."

Recall that in October, Treasurys saw one of the worst market crashes in history, and industry veterans at the time said that it foreshadowed a 2024 recession and 10-year yields breaching 5.5%.