A Historic Quarter for Bonds

By some measures, during the first quarter of 2022 bonds experienced their worst quarter in 40 years as the Barclays Aggregate Bond Index fell just under 6%. Yields on short- and medium-term U.S. Treasuries rose dramatically (prices fall when yields rise) as the two-year yield climbed at the sharpest pace since 1984 and five-year yields increased the most since 1987.

Takeaway: This extraordinary and unusual period reflected the rapid adjustment to a new regime where the Federal Reserve (Fed) is willing to raise overnight interest rates to stem persistent inflation.

Since stocks had negative returns in the quarter as well, bonds did not provide investors the offset to market volatility they have come to expect. In fact, bonds fell slightly more than stocks during the quarter.

Takeaway: Bonds can provide diversification benefits and a cushion to the volatility (or risk) of stocks. However, they don’t always hold up when stock prices fall sharply—especially over short time periods. Over longer periods, bonds normally provide a counterbalance to stock market fluctuations.

As mentioned above, in March the Fed began to pivot toward raising overnight interest rates from near zero. Although the Fed funds rate was only raised one-fourth of 1%, short-term interest rates have already moved sharply higher, which surprised most market forecasters. For example, the two-year treasury finished the first quarter at 2.3% despite having a yield of just 0.7% when the year began. The Fed has signaled additional hikes will continue in 2022 and could result in a Fed funds rate between 2.5% and 3.0%. Financial markets have anticipated those moves and bond prices have declined as yields rose.

Takeaway: Yields on investments ranging from money market instruments to very short-term bonds are becoming more attractive and going forward will provide investors with yields above the near-zero levels of the past two years. It remains unclear if short-term interest rates have fully discounted future Fed hikes—they could drift higher, or they may level out.

Robust economic recovery boosted by stimulative government spending and highly accommodative monetary policy triggered a bout of inflation that was exacerbated by higher commodity prices and stubborn supply chain challenges. Although the unprecedented fiscal stimulus of over $5 trillion resulted in one of the quickest economic recoveries in history, the war in Ukraine accentuated the persistent inflation we are experiencing. The Fed has communicated an even more strident approach to addressing inflation and plans to slow growth but not enough to tip the economy into a recession.

Takeaway: Uncertainty is high. Intermediate- and longer-term interest rates may continue moving higher. However, we still believe bonds can play an important role in portfolios and provide several key benefits, including:

• Dampening overall portfolio volatility
• Providing returns over an intermediate-term time horizon that preserve purchasing power
• Providing dependable cash flow that investors can reinvest at higher yields
• Providing returns that have historically withstood recessions when growth-oriented assets typically decline in price

The first quarter was challenging for our clients as short-term turbulent markets often are. All asset class returns vary and fluctuate but over time tend to gravitate toward returns consistent with their historical experience. At Blue Trust we build investment solutions not to avoid volatility, but to provide appropriate returns for when investments are needed. Consequently, we prepare for difficult market periods through diversification and attention to the client’s desired objectives. In our view, this approach is more effective than attempting to predict market movements or reacting to difficult periods when they occur.

If you have additional questions, please reach out to your Blue Trust advisor or contact us at 800.987.2987.

 

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