Bond market: What to expect in 2023

Yahoo Finance's Jared Blikre looks at the state of the U.S. bond market and its outlook going into 2023.

Video transcript

DAVE BRIGGS: A lot of talk about the bond market. What do we see happening after a brutal year in '22?

JARED BLIKRE: I agree. We're ready to put this year behind us. And so let's take a look at where we are in the bond market. This is basically the entire history of the US. And US bonds right now on track for their top 10 worst return since the birth of the republic. And here we are all the way over in 2022. Here is that negative red candle. That's basically down 14%, 15%. You don't see that often, going back 200+ years.

Now you do see that in this area in here, 1916 to basically 1980-- this is not circling right now-- in here, you do have a lot more down years. But my point of putting this up is that you can have several-- up to five down years in the bond market cluster together. Now, when we talk about the 60/40 portfolio, that adds some diversification. And so if we were to look at what's happened with a 60/40 portfolio since 1950, here is this nasty downdraft that we have right here. That's down 22%. Here is March of 2009, down a little bit less.

Now, what we had going for us in March 2009 was the Federal Reserve was amping up. It was getting ready for a bazooka QE1. And stocks took off to the upside. Bonds didn't do much, but we had this balanced portfolio. So the question is, what happens with correlation? Now this comes from Bespoke, and this shows the rolling three-month correlation between stocks and bonds over the last five years.

In the early days of the pandemic, we shot up, and now we are up here again. That means if bonds are going up, that means if yields are going down, that means equities should be going up and vice versa. And what the problem is, we've been having these scary surprises up in bond yields. So that means bonds are going down, and equities are going down at the same time.

Now, here is the critical chart, and this comes from Jim Bianco. This is where the rubber meets the road. This is what the Fed is forecasting it's going to do in the blue line versus the market, what the market thinks is going to happen in the orange and green line. So the Fed, in 2023, this goes through each month of the year. They think they're going to raise rates in the early part of the year, up to about 5.25%. And then they're going to hold there from May until the end of the year.

The market's saying no. These lines here are what the market expects both before and after the Fed announcement last week. They're saying that there's going to be a come to Jesus meeting sometime. And we're going to see what the difference holds. At that point, in theory, we should get a nice downdraft in yields. And because stocks and bonds are still highly correlated, perhaps at that point, we get that updraft in stocks. And then we get that lift-off that everybody's been expecting.

But the problem that has happened so far this year, everybody's been front running this trade-- has not happened yet. So if it happens in the first part of the year, maybe that's something to look forward to, but not in the present circumstance, guys.