More Balance in Bonds

    | April 11, 2022

    Telemus Weekly Market Review April 4th - April 8th, 2022


    The first quarter marked the worst quarter for bonds in 42 years. Bond yields began the year at low levels and shot higher on the back of rising inflation and an increasingly hawkish posture out of the Fed. As we enter the second quarter, 2-year Treasury yields have risen from 0.15% a year ago to 2.50% today. Current interest rate levels reflect nine to ten hikes from the Federal Reserve over the next two years.

    What’s different today, compared with past rising interest rate cycles, is a more communicative Federal Reserve. Following the Great Financial Crisis in 2008-2009, then Fed Chairman Ben Bernanke ushered in a new policy of more transparent communication, seeking to indicate future Fed intentions well in advance. The logic is that less ambiguity would both make markets more stable and enable them to incorporate future actions into asset prices ahead of the Fed’s actual decision. Over time, the level of transparency has only increased under former Fed Chair Janet Yellen and now Jerome Powell. As we look at markets today, bond yields already reflect a number of future interest rate increases from the Fed, yet thus far they have only increased rates once, by a mere 0.25%. The fact that markets are pricing in this degree of future fed activity is a testament of the Fed’s approach to telegraphing their actions and markets reflecting those expectations.

    It is this open transparency that led to the first quarter being so challenging for bond investors. Many economists had projected that the rate of inflation would start to ease going into the new year, with few expecting the added pressure that came from the conflict between Russian and Ukraine. Combined, these surprises led to an abrupt shift in rhetoric from the Fed, which was quickly reflected into bond prices. Hence, there was little time for investors to react.

    Looking forward there remains a great deal of uncertainty around the number, pace and cadence of rate hikes the Fed will make. Given comments made by various members of the Federal Open Market Committee, even they don’t pretend to know how much or long the rising rate cycle will be. However, as we look ahead, we believe there is more balance in return outcomes for bond investors. The yield on the 2-year Treasury nearly reflects current Fed forecasts for where they expect their interest rate mechanism, the federal funds rate, to be at the end of 2023. While rates could certainty go higher, at current levels, a 2.5% yield on a 2-year Treasury could withstand another 1.25% increase in its yield before experiencing a negative total return. While the possibility exists for this to happen, its not ours or most Wall Street strategist’s base case. Therefore, the possibility exists for modest positive return out of bonds through the remaining three quarters of the year. Given the nearly -6% drawdown in bond prices in the first quarter a positive return for bonds on the year is less likely in our view.

    The path ahead, however, is likely to be anything but steady and smooth. While the Fed is firmly focused on combatting inflation, as the year goes on the magnitude and pace of their actions may become less certain and more data dependent. In addition, along with rate hikes the Fed is also going to be reducing the size of its balance sheet. Given that the Fed has never had anywhere close to $9 Trillion of assets on its balance sheet before, nor have they wound down any more than a few hundred billion, this round of reductions is going to be a first for markets. As markets search to find an equilibrium during this stretch it could lead to some episodes of volatility for yields.

    The drawdown in bonds during the first quarter surprised some the past forty-year downtrend in bond yields has largely led to positive returns. In fact, there have only been four negative years for the bond market over this span, so it’s easy to become conditioned to the stable nature of these instruments. As we move forward, while risks remain, there is an opportunity for investors to generate a positive return if interest rates begin to trend near current levels. On an absolute basis yields remain low, however, they are beginning to offer income-oriented investors a bit more current income. Following a trying quarter, investors should begin to view the range of expected returns among bonds to be more balanced going forward.




    All opinions expressed in this article are for general informational purposes and constitute the judgment of the author(s) as of the date of the report. These opinions are subject to change without notice and are not intended to provide specific advice or recommendations for any individual or on any specific security. The material has been gathered from sources believed to be reliable, however Telemus Capital cannot guarantee the accuracy or completeness of such information, and certain information presented here may have been condensed or summarized from its original source. PAST PERFORMANCE IS NOT A GUARANTEE OF FUTURE RESULTS. Investment decisions should always be made based on the client's specific financial needs, goals and objectives, time horizon and risk tolerance. Current and future portfolio holdings are subject to risk. Risks may include interest-rate risk, market risk, inflation risk, deflation risk, currency risk, reinvestment risk, business risk, liquidity risk, financial risk, and cybersecurity risk. These risks are more fully described in Telemus Capital's Firm Brochure (Part 2A of Form ADV), which is available upon request. Telemus Capital does not guarantee the results of any investments. Investment, insurance and annuity products are not FDIC insured, are not bank guaranteed, and may lose value.


    Advisory services are only offered to clients or prospective clients where Telemus and its representatives are properly licensed or exempt from licensure. No advice may be rendered by Telemus unless a client service agreement is in place. All composite data and corresponding calculations are available upon request.

    Matt Dmytryszyn

    Matt joined the Telemus team in 2018. As Chief Investment Officer, he leads the firms the investment process and research effort. Matt has experience as an equity analyst and portfolio manager and has advised corporate pension plans on their manager selection. He’s been quoted in Money Magazine and Barron’s.

    Matt Dmytryszyn
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