9 June 2023ArticleAnalysis

The impact of interest rates on the bond market through year-end 2023

The bond market, a crucial component of the global financial landscape and the primary component of most captive insurance company portfolios, is highly sensitive to changes in interest rates.

As central banks and governments navigate economic conditions—including the current inflation that has been experienced in the US and globally, fluctuations in interest rates will significantly influence the behaviour of bond investors.

Let’s explore the potential effects of interest rate movements on the bond market through the end of 2023.

Interest rates and bond prices

Interest rates and bond prices share an inverse relationship. When interest rates rise, existing bonds paying lower interest rates become less attractive to investors, leading to a decline in their market value. Conversely, when interest rates fall, bond prices tend to rise as investors seek higher-yielding investments. This inverse correlation is a fundamental principle that shapes the dynamics of the bond market.

Anticipated interest rate trends

For 2023, we have seen interest rates continue the rise that started in Q1 of 2022. Interest rate trends are subject to a variety of factors, including economic indicators, inflation expectations, and central bank policies. Analysts project that the Fed may be close to the end of its “hiking cycle” and that if further rate increases are in the offing, it will probably be at the June and/or July meetings, and then they will pause for the balance of the year.

Impact of rising interest rates on bonds and captive insurance portfolios

As interest rates increase as expected, bond prices are likely to face downward pressure. This was certainly the case in 2022 as the Fed raised rates faster than it ever has before. The Treasury market was hit particularly hard, and most if not all captive portfolios suffered “markdowns” in the value of their holdings.

This is because as new bonds with higher coupon rates become available, existing bonds with lower yields become relatively less attractive. Captives that were forced to sell bonds in the last 12 months likely experienced capital losses if they decided to sell their bonds before maturity. Additionally, the longer the duration of a bond, the more pronounced its price sensitivity to interest rate changes. Consequently, longer-term bonds experienced greater price declines compared to shorter-term bonds over the last 12 months, and that trend could continue through the end of 2023.

Sector-specific effects

Different sectors within the bond market may respond differently to changing interest rates. People who have attended my lectures at captive conferences or on Zoom calls have seen me visually demonstrate the difference in price fluctuations over different classes of bonds.

For instance, government bonds—considered safer investments relative to default risk—are typically more sensitive to interest rate fluctuations. Corporate bonds, on the other hand, can be influenced by a range of factors, including creditworthiness and industry-specific conditions. Since corporate bonds contain both interest-rate risk and credit risk, issuers with increasing creditworthiness may have the value of their bonds increase even as rates increase.

Captives should carefully evaluate the characteristics of each sector and tailor their investment strategies accordingly, and seek diversification by industry sector and creditworthiness.

Yield curve flattening or steepening

Interest rate movements can also affect the shape of the yield curve. Figure 1 compares the yield curve for US Treasuries from June 2022 vs June 2023. A yield curve represents the relationship between bond yields and their respective maturities. When short-term interest rates rise faster than long-term rates, the yield curve may flatten.

Conversely, if long-term rates rise faster, the yield curve may steepen. The shape of the yield curve can have implications for investment strategies, as it provides insights into market expectations regarding future interest rate changes. You can see from Figure 1 that a year ago the yield curve had a “positive slope” meaning that long-term rates were higher than short-term rates. This is called a “normal” curve.

One year later you can see that short-term interest rates are much higher than long-term rates. This is called an “inverted” curve and is often associated with an economy that is heading into recession. Long rates are lower as the market anticipates that the Fed will be forced to lower rates in the future as the economy slows down.

Figure 1: Yield curve for US Treasuries from June 2022 vs June 2023

International considerations

While most captives stick to US bonds, it is important to note that global bond markets are interconnected, and interest rate movements in one country can impact others. For instance, if major central banks increase rates, investors may flock to those currencies, leading to capital outflows from emerging markets. This could result in higher borrowing costs for emerging market governments and corporations, potentially affecting the performance of their bonds.

This is the major risk for emerging market economies and investments, and why I personally don’t feel that emerging market exposure is appropriate for captive portfolios.


As we move towards the end of 2023, the bond market is likely to experience the effects of interest rate movements. As interest rates rise, bond prices may decline, with varying impacts across sectors and maturities. With some pundits—including the Fed governors (Figure 2)—expecting rates to decline in 2024 and beyond, captives should be positioned to take advantage of today’s high rates, as well as preparing for lower rates in the near future.

By understanding the relationship between interest rates and bond prices, investors can adapt their strategies to potentially benefit from the changing dynamics of the bond market.

Figure 2: The Fed dot plot

Past performance is not indicative of future results. All investments involve risk. An investment in this strategy involves a significant degree of risk, including, without limitation, the risk of loss and/or volatile performance. All opinions expressed are current and are subject to change. Forward-looking statements: Any projections, forecasts and estimates (including, without limitation, any target rates of return) contained in this overview are necessarily speculative in nature and are based on certain assumptions. It can be expected that some or all of such assumptions will not materialise or will vary significantly from actual results. Accordingly, these projections are only an estimate. Actual results will differ and may vary substantially from the results shown. The risks associated with investing in fixed income include risks related to interest rate movements as the price of these securities will decrease as interest rates rise (interest rate risk and reinvestment risk), the risk of credit quality deterioration which is an issuer will not be able to make principal and interest payments on time (credit or default risk), and liquidity risk (the risk of not being able to buy or sell investments quickly for a price that is close to the true underlying value of the asset). This article is not and is under no circumstances to be construed as an offer to sell or buy any securities. The information set forth herein has been derived from sources believed to be reliable and does not purport to be a complete analysis of market segments discussed. Opinions expressed herein are subject to change without notice. Additional information is available upon request. Oppenheimer & Co, or any of its employees or affiliates, does not provide legal or tax advice.

Jack Meskunas is a financial advisor with Oppenheimer & Co. He can be contacted at: jack.meskunas@opco.com