BND And AGG: Records Broken, A Head-To-Head Comparison, And 2024 Predictions

November 2023 was the best month for bonds since 1985! But let’s zoom out a bit. The bond market has had a rough past few years. 2022 was the worst year for bonds in the past 250 years. 2023 hasn’t been great, but November was an exception. Was November’s record-breaking performance the turning point in the bond market? I think so. I think bonds are likely to have a great return in 2024.

In this article, I’m going to provide follow-up coverage on Vanguard’s Total Bond Market Index Fund ETF (NASDAQ:BND). Also, in response to a follower’s comment asking about the differences between BND and iShares Core U.S. Aggregate Bond ETF (NYSEARCA:AGG). I will also include a discussion of how these two ETFs differ.

Holdings and Comparison

BND and AGG are very similar but they do have differences. The key difference lies in the index that each ETF tracks. Let’s start with AGG. AGG’s benchmark is the Bloomberg US Aggregate Bond Index. This tracks the total US bond market. BND used this same benchmark until January 2010. Since then, BND has used the Bloomberg U.S. Aggregate Float Adjusted Index. This float-adjusted index is similar to the US Aggregate Bond Index, but the float-adjusted index aims to better represent the bond market that most retail investors have access to. Some bonds are held by corporations, the government, or the Fed and are likely never to be traded. The float-adjusted index takes this into account and represents the bond market excluding these bonds that aren’t likely to ever be traded. So AGG gives you exposure to the entire bond market, while BND gives you exposure to the tradable bond market.

With all that being said, BND and AGG are very similar. Over the past 10 years, BND has outperformed AGG by 0.29%.

This close performance will likely continue. Both have the same expense ratio (0.03%) so you shouldn’t stress over which ETF to pick. Both will provide similar returns and exposure to the US bond market.

A few final notes on their holdings

Unsurprisingly, BND and AGG have extremely similar holdings. It is easiest to show their similarities in a table.

Click to enlarge

Both ETFs are well-diversified and offer broad market exposure to the US bond market. Again, both are so similar, just pick one and don’t stress about choosing the wrong one as their performance will be nearly identical.

Now that the comparison is over, let’s discuss my past coverage of BND and the future outlook for the bond market.

Follow-up coverage on BND

Four months ago, I covered BND and gave it a Buy. My reasoning for this thesis was that I forecasted an end to rate hikes and rate cuts to be coming in 2024. Since my article was published, BND has returned 2.13%, slightly outperforming the S&P 500. Also, it appears my forecast of the end of rate hikes in 2023 and rate cuts in 2024 was correct. Inflation continues to go down and investors are pricing in 115bps of rate cuts in 2024.

Before you give me too much credit, we need to look at why yields have fallen and bond prices have risen. I had figured that by now, we would be in a recession. This would prompt the Fed to cut rates, leading to capital appreciation for BND. The opposite has happened. The GDP in the third quarter rose by 5.2%! Despite the strong recent growth, inflation has fallen and is getting close to being under control. As this happens, real rates are rising. As a result, monetary policy is becoming more restrictive even without the Fed doing anything. At some point, the Fed is going to want to offset this increase in real rates by cutting the Fed funds rate. This is what the market is predicting. As mentioned earlier, the market is pricing in 1.15% worth of rate cuts in 2024. This causes longer-dated bond yields to fall, raising the bond prices. This is why BND and AGG have appreciated.

Likely 2024 scenarios

I think what the market has been pricing in is reasonable. After the latest inflation data, it seems like the Fed has a grip on inflation, and so far, the economy hasn’t shown any signs of weakening to the point of a recession. While a slowdown in GDP is expected in 2024, it isn’t forecasted to be extreme. The St. Louis Fed GDP model estimates 1.3% growth in GDP. If inflation continues to come down and the economy moderates but avoids recession, the Fed will likely cut rates in 2024 (as the market is predicting). I think the consensus of 1.15% of rate cuts is conservative. If this situation plays out, there will likely be more rate cuts. I’d anticipate between 1.25% and 1.75%.

Let’s now assume that the above situation doesn’t play out. Let’s say that the two decade-high rates cause so much strain on the economy that we enter a recession. There is a lag effect to rate hikes. So while the economy is chugging along now, a recession isn’t out of the picture. After last quarter’s 5.2% rise in GDP, the fourth quarter’s GDP is expected to only rise 1.2% according to the Atlanta Fed GDP model. While these numbers don’t indicate a recession, they do show a slowdown. If a recession does happen, the Fed will cut rates to stimulate the economy, likely by even more than in the scenario above. My forecast would be about 2%-2.50% worth of rate cuts. This will cause BND and AGG to appreciate.

The situations that could hurt the bond market

If inflation cools and there is no recession, BND and AGG will appreciate, but if there is a recession, they will appreciate even more. Obviously, there is still risk to this investment. Despite recent progress, if inflation is sticky and doesn’t come down, the Fed will keep rates higher for longer. The Fed expects inflation to go back down to 2% by 2025, but if the Fed’s progress toward this goal stalls, they will be reluctant to cut rates. This will likely cause a bear-steepening leading to higher long-term yields and lower bond prices. This would be bad for our bond ETFs. But this situation is very unlikely. Inflation would have to get stickier and the economy would have to continue to perform well. I don’t see this happening. Inflation has been steadily coming down and I don’t see that changing.

Also, there is a potential supply-demand problem with US treasuries. There is a very large supply with the growing US deficits and concerns about adequate demand to keep rates low. Despite all these risks, I feel the odds heavily favor conditions that are favorable to BND and AGG

Takeaways

BND and AGG are very similar. I believe they will have a good 2024. Rates will likely get cut in 2024 leading to appreciation for these ETFs. It would take a very unlikely scenario for rates to remain the same in 2024. Inflation has been steadily coming down and there is no reason to expect that to stop. I rate BND and AGG a Strong Buy.