What the Fed’s Biggest Rate Hike in Decades Means for the Bond Bear Market
Historically bad. That’s how the massive $53 trillion US fixed income market has behaved this year as the Federal Reserve scrambles to curb high inflation that threatens to destroy the economy.
To boost the effort, the Fed on Wednesday triggered its largest benchmark interest rate hike in nearly three decades. But what does this mean for fixed income investments already deep in the red?
MarketWatch took the question to several fixed-income professionals to gauge what’s next, given the worst bear market in U.S. bonds in decades.
What the 75 basis point rate hike means
The Fed finally seemed ready to rip the band-aid off to help cool inflation to a four-decade high, with its giant rate hike this week.
Investors said the move could add to the pain in financial markets in the second half of the year. Or it could also pave the way for greater market stability, potentially signaling that the worst of the storm is over.
“The 75 basis point rate hike means there is more comfort and confidence that the Fed is keeping inflation under control,” said Daniela Mardarovici, co-head of multi-sector fixed income at Macquarie Asset Management, at MarketWatch.
“At the previous meeting, Chairman Powell let the world know that the Fed understands the impact of inflation. This time those words became actions,” Mardarovici said.
However, she also said it is “highly unlikely that we have seen the end of market apprehension and illiquidity” given that there are still a few more rate hikes before the Fed does. comes to its new point forecast of a benchmark rate close to 4% by the end of next year.
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How bad are bond yields?
To get a sense of the rout in 2022, the roughly $10 trillion U.S. corporate bond market has posted a negative total return of 15.8% so far this year for its large investment-grade segment, according to data from CreditSights.
In dollar terms, the shock sale has more than $300 billion in highly rated corporate bonds trading at prices below $75, from Apple Inc. AAPL,
to JP Morgan Chase & Co. JPM,
according to BofA Global.
Returns for the US aggregate bond index were negative 10.7% and minus 9.9% for US Treasuries, in the year to June 10, according to the team’s latest weekly report. fixed income securities of Nuveen.
“ “What may be market volatility for some is the ability to feed children, drive to work and stay in a home for millions more in the United States alone.” ”
“Most likely, 2022 will be an historically bad year for fixed income,” Christopher Heckscher and William Hines, fixed income investment managers at abrdn, told MarketWatch.
Even so, the kind of yield offered by fixed-income securities for the rest of 2022 will be more relevant, they said, given the rise in yields in the bond world. Yields on US investment grade bonds have climbed to nearly 5% this week from around 2% a year ago. They were indexed at nearly 8.5% this week for high yield bonds or “junk bonds”.
Higher yields could help fixed income recoup some of the negative performance, but Hines and Heckscher still believe investment-grade corporate bonds could post a negative 10% total return for the whole stock. year 2022. On the other hand, they said that the current minus 16% level could persist if longer-term rates continue to climb.
“Unfortunately, the extremely strong returns for 2019 (+14.5%) and 2020 (+9.9%) had to be returned at some point, with rates and spreads both squeezed to extremely tight levels – a a lot of that being the Fed’s doing,” the team said.
Rising rates this year have been a major culprit for negative fixed income returns since November, when the Fed began signaling that it would tighten inflation.
The 10-year Treasury TMUBMUSD10Y,
the yield fell to 3.2% on Friday, after hitting an 11-year high earlier in the week. Stocks gave back all of their post-Fed gains and more, putting the S&P 500 SPX index,
on pace with a 6% weekly decline, according to FactSet. The rout has officially joined the Nasdaq Composite Index COMP,
in a bear market.
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Slowing economic growth, coupled with weak corporate earnings, rising interest rates and slowing inflation, could put US corporate credit issues back in the spotlight. However, there were costs, beyond Wall Street, to consider.
“There is absolutely a silver lining to tighter financial conditions,” said Macquarie Asset Management’s Mardarovici.
“The underlying impact of inflation on billions of people around the world has been so severe and negative that the Fed was almost forced to act to return to a healthier global economic environment,” he said. she declared.
“What may be market volatility for some is the ability to feed children, drive to work and stay in a home for millions more in the United States alone.”
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