As we approach the end of a first quarter filled with macroeconomic and geopolitical events, stocks finished the last two weeks in positive territory, which feels like a win, albeit a small one. Even with the negative events that have occurred to start the year, the S&P 500 Index is down just 4.4%, through the end of last week. While stock markets tend to receive the most attention, bond yields might be the bigger story as bond indexes are further in the red than stocks so far this year.
Interest rates have been in a long-term downtrend since the 1980s, leading investors to expect bonds to generate consistent, positive returns year after year. Bond prices increase as yields fall. The 10-year U.S. Treasury tends to draw the most attention, especially last Friday when it briefly traded at 2.5%, marking the first time in about four years the 10-year yield has increased above that level.
While a 10-year bond with a 2.5% interest rate can seem low, it is a significant event relative to the past decade, whether on the lending or borrowing side. To put this in perspective, since the end of the Financial Crisis in 2009, the 10-year Treasury yield has averaged 2.2% and traded below the current 2.5% yield about two-thirds of the time. For a short-term comparison, the 10-year yield traded at the lowest level ever, not even two years ago, at 0.55%, almost 2% lower than the current rate.
What is forcing interest rates to increase? The obvious answer is inflation, but an expanding economy and expectations of additional Federal Reserve rate hikes are also contributors. Markets have been expecting six additional 0.25% rate hikes from the Fed this year. Last week Fed Chair Jerome Powell announced 0.50% rate hikes could be considered at some meetings to combat rising inflation more aggressively. As Fed-controlled short-term rates are increased, this puts pressure on longer rates to rise to avoid an inverted yield curve, whereas shorter-term rates yield more than longer-term rates. For the record, there are some parts of the yield curve currently inverted, like the 3-, 5-, and 7-year rates yielding more than the 10-year rate, but that is a discussion for another day.
Investors can be led to question their bond allocations as some media outlets phrase this scenario as dire. Although bondholders may not experience as much price appreciation from their bond allocations that they have become accustomed to, bonds still have a yield component, which is now higher. Just because rates are rising does not mean losses are locked in for bond portfolios; active managers are reinvesting cash flows into what are now higher-yielding bonds. So, while investors may not capture as much appreciation, income is still an important factor that is only increasing as rates rise.
Author: Joe Clark, CFA | Research Team | Allegheny Financial Group | March 2022
The information included herein was obtained from sources which we believe reliable. This report is being provided for informational purposes only. It does not represent any specific investment and is not intended to be an offer of sale of any kind. Past performance is not a guarantee of future results.
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