Historically bad. That’s how the mammoth $53 trillion U.S. fixed-income market has performed this year as the Federal Reserve works to curtail high inflation threatening to wreck the economy.
To turbo charge the effort, the Fed on Wednesday fired off its biggest benchmark interest rate increase in nearly thirty years. But what does that mean for fixed-income investments already deeply in the red?
MarketWatch put the question to several fixed-income professionals to gauge what comes next, given the worst bear market in U.S. bonds in decades.
What the 75-basis-point rate hike means
The Fed finally appeared ready to rip off the Band-Aid to help cool inflation at a four decade high, with its jumbo-sized rate increase this week.
Investors said the move could bring deeper pain for financial markets in the year’s second half. Or it also could pave the way for greater stability in markets, potentially signaling the worst of the storm has passed.
“The 75bp rate increase means there is greater comfort and confidence that the Fed has a grasp on inflation,” Daniela Mardarovici, co-head of multisector fixed income at Macquarie Asset Management, told MarketWatch.
“At the previous meeting, Chairman Powell conveyed to the world that the Fed understood the impact inflation was having. This time those words became actions,” Mardarovici said.
However, she also said it is “highly unlikely we’ve seen the end of apprehension and illiquidity in the market,” given quite a few rate hikes remain before the Fed gets to its new dot-plot forecast of a near 4% benchmark rate by the end of next year.
How bad are bond returns?
To get a sense of the rout in 2022, the roughly $10 trillion U.S. corporate bond market has posted a negative 15.8% total return so far this year for its large investment-grade segment, according to CreditSights data.
In terms of dollars, the shocking selloff has more than $300 billion of highly rated corporate bonds trading at prices below $75, from Apple Inc. AAPL, +1.15% to JP Morgan Chase & Co. JPM, -0.35%, according to BofA Global.
Returns for the U.S. aggregate bond index were negative 10.7% and minus 9.9% for U.S. Treasurys, on the year through June 10, according to Nuveen’s fixed income team’s latest weekly report.
“ “What may be market volatility for some, is the ability to feed children, drive to work and stay in a home for millions of others in the U.S. alone.” ”
— Daniela Mardarovici, co-head of multisector fixed income at Macquarie Asset Management
“Most likely, 2022 will be a historically bad year for fixed-income,” Christopher Heckscher and William Hines, fixed income investment managers at abrdn, told MarketWatch.
Even so, what kind of return fixed-income offers for the rest of 2022 will be more relevant, they said, given climbing yields across the bond world. Yields on U.S. investment-grade bonds shot up to nearly 5% this week, from about 2% a year ago. They were at pegged near 8.5% this week for high-yield, or “junk bonds.”
Meatier yields could help fixed-income claw back some of the negative performance, but Hines and Heckscher still think investment-grade corporate bonds could record a negative 10% total return for the full year 2022. On the flip side, they said the current minus 16% level could persist if longer-term rates continue to press higher.
“Unfortunately, the extremely strong returns for 2019 (+14.5%) and 2020 (+9.9%) had to be given back at some point with rates and spreads both being pressed to extremely tight levels — a big part of that being the Fed’s doing,” the team said.
Surging rates this year have been a key culprit of negative fixed-income returns, starting back in November when the Fed began signaling it would get tougher on inflation.
The 10-year Treasury TMUBMUSD10Y, 3.236% yield declined to 3.2% Friday, after hitting an 11-year high earlier in the week. Stocks gave back all their post-Fed gains and more, putting the S&P 500 index SPX, +0.22% on pace for a 6% weekly decline, according to FactSet. The rout officially joined the Nasdaq Composite Index COMP, +1.43% in a bear market.
Slowing economic growth, coupled with crimped corporate earnings, from higher interest rates and the drag of inflation could put credit issues in American corporations back focus. However, there have been costs, beyond Wall Street, to consider.
“There is absolutely a silver lining to tightening financial conditions,” Mardarovici at Macquarie Asset Management said.
“The underlying impact of inflation on billions of people around the world has been so severe and so negative that the Fed was almost forced to act in order to return to a healthier global economic environment,” she said.
“What may be market volatility for some, is the ability to feed children, drive to work and stay in a home for millions of others in the U.S. alone.”