Market Update - What's Happening With Bonds?

Benjamin Haas |


Benjamin Haas  00:05

Hi, everyone and welcome Adam. We have become a little bit more comfortable sharing information through this format and thought, because we're getting a lot of questions around bonds specifically, and really what has been some of the worst losses in the bond market in quite some time. We thought we'd use this format to kind of go through a little Q&A go through some high level points on really not only what is happening, but try to provide some comfort on where we think things are going. Because in the context of how we present things in financial planning, it's never fun to see losses. People expect volatility with their stocks, but not so much with their bonds. So, Adam, help me kind of kickstart this by just really talking about what has transpired in the first quarter with interest rates, inflation, Federal Reserve. Give us a little backdrop.

Adam Werner  00:57

For anybody who has looked at their first quarter statement, or at least their most recent monthly statement has seen, the beginning of this year has not gone well, for many investments. In fact, almost all investments are at some sort of a loss here to start the year. Which you said it, and I will reiterate it, I think to a certain degree people expect or are used to seeing some volatility with their stock market investments. That's been ingrained over a long period of time, if you've been an investor for a while. I think more recently, the fact that bonds, which have always been kind of touted for their stability, they're going to zig when the stock market zags. That has not been the case to start this year for many different reasons, which we'll talk about. But I think that's been the biggest kind of mental hurdle to understand. Well, I see that, why are my bonds down 5 to 9%, in a three month period. That just doesn't compute when you think about the risk level that is being taken. So go ahead, you're gonna say something.

Benjamin Haas  02:13

Thinking mechanism of bond, you can certainly purchase a bond, which is a promise to provide an interest rate for a set period of time, but the way that most of our clients would have access to that is through some sort of mutual fund. Or some sort of packaged product. And I guess the point is, we would want people to understand that as interest rates go up, prices go down, or vice versa. And speaking to our more conservative group, you can probably remember a home loan that was at 10%. And here, the generation buying right now was getting a 2% loan or 3% loan, as those interest rates were dropping prices were good for bonds. We've now had to see a little bit of that reversal and as those interest rates are going up, we're seeing I'm trying to look at the note here, nearly 7% decline in the value of the 10 year Treasury in the first quarter. A loss of 7%. That feels like a stock loss to your point. Right. Well, and it kind of is the the stock market is down roughly in that same range to start the year. And that's that's the part that I think feels the weirdest, to have your your bonds be losing as much as your potentially more risky stock investments.  Why are interest rates going up as much as they are?

Adam Werner  03:32

So I was gonna go all the way back to March of 2020 COVID shutdown happens. The Federal Reserve acted quickly to reduce their interest rate policy, essentially to zero. And that was all in the effort to add liquidity to the system. They were doing bond purchases at that same time. It was really to prop up the market and the economy in what was a very tenuous time. Well, now here we are two years removed. Two years? Man, two years removed from that and now we're having to deal with that. So the Federal Reserve was successful in that sense. Everybody knows now that 2020 in calendar year returns were strong for both stocks and bonds. Which in hindsight is still just feels weird to think about. 2021 stock market did well. Bonds not so much. Bonds were maybe slightly negative to flat for the year, for 2021 calendar year. Now here we are, going back to December, the Federal Reserve made a pretty hard pivot to their strategy now moving forward. They went from being very accommodative. We're going to do whatever we need to get this economy back in a spot where we feel it's comfortable and growing. To now inflation has stuck around at a much higher level and is much stickier than they had expected. So now their mandate has transformed from we need to make sure the economy's in on good footing to inflation is a real problem, we need to start combating that. And they only have so many tools at their disposal, to either raise interest rates and or reduce the level of their balance sheet. The bonds that they've bought through the pandemic, they're now starting to unwind that process. And that's just increasing the volatility in the bond market.

Benjamin Haas  05:34

Right. And I guess, as you're saying that ,my follow up question to this was, then why did it happen so quickly? Because at this at this point, the Federal Reserve, we have said in different places, they are trying to telegraph what they're doing. But at this point, they have raised the federal funds rate by one quarter of 1%.

Adam Werner  05:56

They're off of the starting range of zero to a quarter point. So really, where they're at now is a quarter to half a point, half a percentage point is their target or their interest rate range right now. So still essentially zero, even though the 10 year Treasury is now at roughly 2.7, depends when you look at it. It really, truly is volatile lately, but we started the year with the 10 year treasury and we say the 10 year Treasury because that's kind of the benchmark to really see interest rate movements. And in theory, it's a treasury bond, that is backed by the full faith of the US government. That's as close as you can get from risk to risk free, as opposed to cash. So that 10 year Treasury started the year around 1.5%. Now we're upwards of 2.7, over a three month period. So you just think about that in terms of percentage 1.5 to 2.7. It's almost doubled.

Benjamin Haas  06:59

Yeah, 100%.

Adam Werner  07:00

In that timeframe. So going back to what you said the the Federal Reserve has done a really good job of trying to telegraph everything that they're going to do from a policy standpoint, because they understood or understand at this point that the market, both stock and bond market, do not like surprises. So they've actually and it's very interesting to see how they've taken this now, and kind of used it. Have that knowledge and are using it to have the markets do a lot of that heavy lifting before they ever actually enact any of the policies. So in late in December is when the Federal Reserve kind of made their announcement that they were going to pivot policy. And from from then on, interest rates have started to climb. And then when more news came out, in their most recent meeting, really that shift from being what is called dovish, meaning very accommodative. We're going to be slow and steady to what is now considered hawkish, so more aggressive to fight inflation, which doesn't bode well for interest rates. That just their change in rhetoric has completely reset the market for bonds. And ultimately, stock and bond market is trying to be predictive. Trying to be forward looking, knowing what we know, trying to extrapolate all of these variables, all these assumptions out, whatever, 6, 12, 18 months, and trying to back their way into, okay, if we think XYZ is going to happen, or here's we're going to end up, then what do I think this bond is worth in today's environment? So that's where you can get that huge disconnect between what the Federal Reserve has actually done, and what the market has done with that information.

Benjamin Haas  07:01

I think I would want investors I'd want clients to then recognize that what has happened in the bond market is what we've been talking about with the stock market in recent years too. When you feel like there is a change of the rules or a change of the environment. It's a very quick reset, right? What used to be a slow drag, over a long period of time has become very quick. Even our most recent example we use is clearly the onset of COVID-19. The stock market went down 30% within 30 days, but within the next 90, 60 to 90 days, it was back to even those that is in historically quick moves. And it seems like that has happened here in the bond market, too. It's almost like the Federal Reserve said here's our intent, like you said they haven't done it yet. And the market ripped that band aid. Which I guess leads me to a follow up question for you. Does that I know you're not going to sit here and tell me where it's going. But

Adam Werner  09:52

Right right.

Benjamin Haas  09:53

Does that does that mean for bond investors that a lot of the pain has already been felt or is there a lot more to be felt?

Adam Werner  09:59

Yeah, so I certainly am of the mindset that I think the majority of that pain is already behind us. To your point, not just the how far rates have moved, that 1.5 to 2.7. But it is the swiftness with which that happens. And to your point with the stock market, the going back to COVID. Those downturns have recently happened very quickly. And those rebounds have happened just as just as fast. I think that's more novel on the bond side, where rates truly feel like they spike over that short term period of time. And just historically, we've seen, usually this is in response to the stock market, that pendulum often over swings way too far, one direction before swinging, possibly swinging back the other direction and ending up somewhere in the middle. So I kind of feel like that's where we're at with the bond market that we've seen this historic move, right now. Can rates trickle higher from here? Yes. And that's probably going to be the case. But to keep up, for rates to continue to rise at the pace that they did in the first quarter, we're just not in a scenario here economically, policy wise, we're just not in that scenario, I don't think where rates can now go from 2.7 to 3.9. I don't think we're anywhere near that as kind of our base case, essentially, that the difference between where the Federal Reserve is with their policy right now call it a quarter point to the 10 year Treasury being at 2.7. There's a lot of wiggle room in there for them to continue to actually enact their policy before a bond market truly is at what may be considered a fair value. So moving forward, I think there's certainly more potential for rates to trickle higher. But that's much easier for the bond market to digest those incremental movements than it is the bigger swings over short periods of time.

Benjamin Haas  12:09

Yeah, and I know in preparing for this, you did a little research on really how far we've come. But really, if not look at what feels like or should feel like recent history. The 10 year treasury was where at the end of 2018?

Adam Werner  12:24

Yeah. So this was was shocking to me. And I know when we talked about it, it's weird to think. At the end, I don't know if it was at the end of 2018. But sometime towards the end of 2018, the 10 year Treasury was at 3.2%.

Benjamin Haas  12:39

Down to like 2.8 today ish.

Adam Werner  12:42

Yeah. Yeah. So it's clearly, if you think of it in that sense, we're talking four years from 2018 to now to go from 3.2 to 2.7. That doesn't feel like a huge move. But the trajectory has not, longer periods of time on a graph, you can smooth out that line. Where really, going back to 2020, when COVID hit and the Federal Reserve dropped interest rates essentially to zero. I mean, there were bonds across the world that were actually yielding negative interest rates, which I don't know if we've ever talked about that on the podcast, but the thought of the thought of rates, you're paying someone to give you less money 10 years later future just does not compute. But yeah, the fact that the 10 year Treasury rate was 3.2, three and a half years ago, I certainly fell into that recency bias that I just felt like we've been less than two for as long as I can remember, just based off of the COVID shutdown.

Benjamin Haas  13:51

Yeah, I think that's because the market was so good for so many years. It maybe got lost that your bonds were actually contributing to some of your returns in an inflated way. That you weren't just collecting a decent interest rate, but the value of your bonds when we went from 3.2 in 2019, it was a decent year for the stock market. And they started dropping back down that you were reaping those rewards as a bond investor. So, this first quarter feels pretty bad. But I wonder without knowing, if we did try to level out some of those returns really, we're just trying to find our way. Right now we're trying to find our way back to what feels more normal in the bond market. It just has happened very quickly.

Adam Werner  14:40

So I guess the the point is from here, and I think the question that we often get is, Well, where do we go from here?

Benjamin Haas  14:49

Should we do something different?

Adam Werner  14:51

Yeah. Should we be should we be selling our bonds now and doing something different? And this goes back to part of the conversation earlier that where we believe most of that pain has already been felt, making a drastic change now, really your alternatives are, you're gonna either gonna hold more cash in lieu of holding the bonds, or you're really going to ratchet up your risk by now owning stocks instead of those bonds. And just fundamentally and philosophically speaking, that's not necessarily a bet that we're willing to make at this stage. So really moving forward, it kind of feels anticlimactic to say, stay the course. But that's kind of where we're at. I believe, from here on, there will be volatility. But we should start this slow climb out of the hole that has been dug to start the year for both the stock and the bond market. That making any any huge drastic bet, or shift right now just feels like it's ripe for getting that timing wrong.

Benjamin Haas  15:56

And I guess, said differently. If you feel like a lot of the potential negatives are known things, then what we're looking for is that those known things aren't going to get worse. And it can be on the other side, the things that have been, or have you still feel positive corporate earnings, maybe some of the fundamentals in the market, if you believe those things can remain positive, then it really is not to be making huge shifts. And I think that's why it's important to go through these things and kind of say, here's what happened this quarter. But any decision that I would hope any investor makes is not based on what happens in one quarter. It's based on long term viewpoint on where where do we see things going. And I hope this was helpful on that front.

Adam Werner  16:46

And if anybody listening to this wants to talk about, you know, their investments, specifically their situation, do not hesitate to reach out that's why we're here.

Benjamin Haas  16:56

Well said. Thank you for your commentary and input today.  Likewise.  Thank you.


1. Source: Bloomberg, 4/29/1942 - 12/31/2021. Past performance is no guarantee of future results. For illustrative purposes only and not indicative of any actual investment. Investors cannot invest directly in an index.
2.   Source: Bloomberg, 1/1/2022 – 4/14/2022. Past performance is no guarantee of future results. For illustrative purposes only and not indicative of any actual investment. Investors cannot invest directly in an index.


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