Assessing the impact of rising rates on Fixed Income Performance
As inflation measures reached their highest levels in 40 years and with US GDP growing at an annualized 6.9% for 2021, the Federal Reserve finally began raising rates in March, and FOMC members have intimated an aggressive tightening plan with multiple hikes anticipated in 2022, 2023, and 2024 focused on controlling inflation. They followed through on this plan at their most recent meeting by raising rates 50 basis points, their first 50 bp hike since 2000.
Treasury yields had been rising steadily since August 2021, but jumped sharply in March partly in reaction to the Fed comments from those meetings. For the 5-week period ending April 8th, the 2-year US Treasury Yield rose by over 1%, its sharpest 5-week increase since 1987.
This led to some of the worst performance across the bond market in recent memory:
|Ticker||Fixed Income Asset Class||YTD Return through 5.4.22||1-Year through 5.4.22||Price % Off 52-wk High as of 5.4.22|
|AGG||Aggregate Bond Index||-10.4%||-8.5%||-11.8%|
|LQD||Investment Grade Corporates||-15.5%||-11.9%||-17.0%|
|TIP||US Treasury Inflation Protected||-6.7%||-0.3%||-8.8%|
|SHY||Short Term Treasuries||-3.0%||-3.4%||-3.8%|
|IEF||Intermediate Term Treasuries||-11.5%||-9.2%||-13.4%|
|TLT||Long Term Treasuries||-22.2%||-13.6%||-23.5%|
As you can see the pain is being felt by bond investors across all segments of the fixed income market with many indices more than 10% below their 52-week highs. The Bloomberg US Aggregate Bond Index’s -5.9% return in the first quarter was its worst quarterly return since 1980, and the Long Term US Treasury Index is trading more than 23% below its 52-week high just to highlight a few impacts from the historic rise in rates.
While it has certainly been painful for bond investors in the short term, there are still some silver linings to higher interest rates, particularly for investors with longer time horizons:
- Higher income from fixed income allocations. The cash from coupons and maturing issues can get reinvested at higher and higher rates.
- More protection during equity selloffs. Higher rates = higher expected returns = more cushion from fixed income allocations during recessionary environments.
- Economic growth prospects. Rising rates can signal positive growth expectations for the overall economy.
The unique environment that we’re in currently with both high inflation and rising interest rates is one that is not conducive to generating strong returns in either stocks OR bonds, and has many investors questioning the role of fixed income securities in a diversified portfolio.
However for long-term investors, the short-term pain of holding bonds in a rising rate environment can be offset by the long-term benefits of increased income and better downside protection that come as a result of higher rates. With Investment Grade US Corporate Bond Indices now yielding over 4% (up from ~2% to begin the year), they present a much more attractive option for income and downside protection than they have the last 10 years.
Andrew Gibson, CFA
Related article links:
WSJ: ‘April Extends Bond Investors’ Woes’ (paywall):
Bloomberg: ‘Stocks Succumb to Bond-Market Rout as Fed Inflation Hawks Circle’
The posts expressed are views of FSTC and are not intended as advice or recommendations. For informational purposes only. FSTC does not offer tax, legal, or investment advice, professional counsel should be sought for tax or legal advice.