It seems obvious now! Hawkish Fed, huge fiscal stimulus, big pickup in inflation; everyone knew interest rates were going to go up and short bonds were going to outperform long bonds! But, it wasn’t obvious! The Fed is moving to control inflation and simply getting interest rates closer to a “normal” level, the fiscal stimulus simply replaced private sector economic activity that was diminished by the global pandemic, and the pickup in inflation, though serious, is simply catching up to a 2.25% long term trend line from its sub-2% levels of the last 10 years.
Bonds with a short “duration” have less interest rate risk, i.e., the risk of prices going down when rates go up, compared to long bonds. For example, a bond with an effective duration of 2 years will fall in value by 2% when rates increase 1.00% (e.g., from 2% to 3%), compared to a bond with an effective duration of 9 years that will fall by 9%. This is simple bond math.
But, just like in the stock market, no one can predict the bond market. Per the table below, though short bonds (NEAR) have outperformed long bonds (LQD) on a year-to-date and 2-year time horizon, over longer 3- and 5-year horizons long bonds have outperformed short bonds.
Underweighting long bond exposures was a prudent strategy over the last two years given the risk-return tradeoff when rates were at historic lows, but re-targeting bond exposure to shorter bonds over a longer time horizon would have missed some of the longer-term positive return.
So, going forward there is plenty of risk in the market, but as I am known to say, best to stick with a long-term strategy attuned to your risk profile and targeted to help you achieve your goals.