Slowing U.S. inflation has ignited optimism for a much-needed revival in the $10.6 trillion U.S. corporate bond market.

Bonds issued by some of America’s largest and most prominent companies, including Apple Inc., Amazon.com, Microsoft Corp., and Johnson & Johnson, have experienced a significant decline in prices. The decline can be attributed to the Federal Reserve's series of interest rate hikes over the past 18 months.

The impact of these rate hikes has been particularly harsh on low-coupon, longer duration bonds. As the Federal Reserve rapidly increased its policy rate, older bonds with lower coupon rates became less valuable. This decline in value can be attributed to major corporations and the U.S. government issuing newer bonds at yields not seen since the 2007-2008 global financial crisis.

According to Collin Martin, a fixed-income strategist at Schwab Center for Financial Research, many investors were caught off guard by the drop in bond values and had limited options to protect their investments.

To illustrate the extent of the damage, BondCliq Media Services created a hypothetical portfolio consisting of long-duration, high-quality U.S. corporate bonds with a starting value of almost $1 million in January 2022. They closely monitored the impact of the Federal Reserve's rate hikes since the spring of 2022. As of Tuesday, the portfolio's value was estimated to be around $650,000, marking a substantial decrease.

However, Martin believes that the future holds more promise for bond investors. He states that given the Federal Reserve's outlook, it is more likely that bond prices will rise over the next 12 months rather than fall. Schwab Center for Financial Research expects the next move from the Federal Reserve to be an interest rate cut, as inflation continues to slowly subside from its peak levels.

The ICE BofA US Corporate bond index, which has a duration of approximately 6.5 years, has experienced a slight increase in price from its October lows. It currently stands at 87.31, compared to its low of 85 in October. However, the index is on track to deliver a total return of 1% for the year, according to FactSet data.

Bond Prices and Investor Impact

Lower bond prices can have significant implications for investors, particularly if they are compelled to devalue their holdings or sell them at a loss. This was evident in the downfall of Silicon Valley Bank back in March.

Declining U.S. Bond Yields

On Tuesday, there was a notable decline in U.S. bond yields, triggering a surge in the stock market, specifically the SPX index. This drop was prompted by the October consumer price index, which reported lower inflation than expected, indicating an annual rate of 3.2%. This figure marked a decrease from September's 3.7%.

Implications for the Fed

Despite the inflation rate remaining above the Federal Reserve's target of 2%, traders opted to factor in a potential 50 basis points reduction in the central bank's policy rate by July 2024. The CME FedWatch tool provided this insight.

"The broad market consensus is now in line with our own expectation that the least Fed rate hike of the cycle occurred this summer," stated BCA Researchers in a client note on Tuesday.

Bond Price Fluctuations

While price fluctuations in bonds may not be of great concern when the debt is held until maturity and fully repaid at par ($100), investors are typically interested in purchasing bonds at significant discounts that are poised for a rally, akin to stocks.

The 10-year Treasury yield (BX:TMUBMUSD10Y) dropped 19.1 basis points on Tuesday, averaging around 4.42%. This decrease follows an October peak of approximately 5%. It's important to note that bond prices move inversely to yields.

Investor Strategy and Recommendations

Lauren Goodwin, an economist and portfolio strategist at New York Life Investments, advises investors to take advantage of any relief rallies by rebalancing their portfolios with a focus on long-term durability. She specifically recommends considering adding duration as long rates continue to decline.

Read: Economists in the Hawkish Camp Don't Surrender in Wake of October's Consumer-Inflation Print

Other Market Movements

In addition to corporate debt, the popular iShares Core U.S. Aggregate Bond ETF (AGG) saw a 1.3% increase on Tuesday, according to FactSet. Meanwhile, the Dow Jones Industrial Average (DJIA) appeared set for a 1.4% gain.