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4 min read . Updated: 24 Apr 2022, 04:15 PM IST The worst bond rout in decades shows few signs of abating, threatening further pain for both investors and borrowers.
Battered by high inflation readings and sharp messages from Federal Reserve officials about the need for interest-rate increases, bond prices have tumbled this year at a pace investors have rarely seen. In the first quarter, the Bloomberg U.S. Government bond index returned minus 5.5%, its worst performance since 1980. This month, it has lost another 2.4%.
As of Thursday’s close, the yield on the benchmark 10-year U.S. Treasury note was 2.808%, its highest level since late 2018 and up from 1.496% at the end of last year. Yields rise when prices fall.
Rising Treasury yields are in many ways a reflection of a robust economy. A big reason why many investors expect continued high inflation in the near term is that households are flush with cash and eager to spend their money on travel and leisure activities as they begin to worry less about the Covid-19 pandemic. The labor market is also, by some measures, the tightest in decades, giving workers leverage to demand better wages and confidence that they can always find a different job if they lose their current one.
These forces, though, are precisely why the Fed has been trying to push up bond yields by promising a rapid series of interest-rate increases—an effort whose urgency hasn’t been diminished by a modestly encouraging inflation report last week. Many investors are saying they expect bond prices to continue to fall this year, and some contend it won’t be clear that the central bank’s message is getting through until stock prices suffer more serious declines.
“We’re coming out of one of the worst quarters in history…and the big bear market in bonds continues," said Thanos Bardas, global co-head of investment grade and a senior portfolio manager at Neuberger Berman.
Treasury yields largely reflect expectations for short-term rates over the life of a bond. They in turn set a floor on borrowing costs across the economy. The Fed, now, wants borrowing costs to rise to slow consumer demand and bring down inflation—and it is succeeding at least in the first of goals, with the average 30-year mortgage climbing last week to 5% for the first time since 2011.
While rising yields are tough for investors, there were, analysts said, some glimmers of hope in the latest inflation report.
Overall, the consumer-price index increased 1.2% in March from the previous month, the Labor Department said, bringing year-over-year inflation to another 40-year high at 8.5%. Still, core prices—excluding volatile food and energy categories—rose a more modest 0.3%, their smallest monthly gain since September.
Dragging on core inflation, used-car and truck prices fell 3.8%—a sign that some of the components of outsize inflation over the past year could come back to earth this year as consumers shift their spending patterns and businesses sort out supply-chain problems.
Treasury yields fell after the data release. But they were back up again by the end of the week, with bond investors saying that one report wasn’t enough to put them at ease.
“It doesn’t change anything," said Zhiwei Ren, a portfolio manager at Penn Mutual Asset Management.
Investors, he added, already expected inflation to peak in March. But it is still likely to plateau well above the Fed’s 2% annual target, causing the central bank to keep signaling more interest-rate increases beyond what investors are already expecting.
One hope of some bond investors is that surging consumer prices, coupled with higher borrowing costs, could slow consumer demand in relatively short order. In that case, the Fed could keep tightening monetary policy, but officials wouldn’t feel the need to raise their rate forecasts further, allowing bond yields to stabilize.
Mr. Bardas, for his part, said his team recently adjusted portfolios so that their vulnerability to rising interest rates would be roughly the same as the bond index they track—a shift from their previous posture designed to outperform the index if yields rise.
Yields have climbed enough, he said, that it seemed appropriate to take a more wait-and-see approach. Yet he was hardly celebrating after the inflation report, saying he would need to see consecutive readings of 0.2% monthly core inflation before he started to feel more confident about the outlook. Other fund managers, such as Mr. Ren, are still positioned for higher yields.
Guessing the final destination of interest rates is extremely difficult, he said, but one sign that the Fed might need to do more than currently expected is that stocks, as a whole, have only experienced modest declines, with the S&P 500 down 7.8% year-to-date.
Right now interest-rate derivatives show that investors expect the Fed to raise its benchmark federal-funds rate from its current level between 0.25% and 0.5% to just above 3% next year.
If the market starts pricing in a 3.5% fed-funds rate and stocks fall another 10%, that might suggest that the Fed will stop at 3.5%. But if stocks barely budge, “That tells you [Fed officials] have to do more," Mr. Ren said.
This story has been published from a wire agency feed without modifications to the text