During 2020 and 2021, aggressive measures were taken to stimulate the economies, resulting in an increase in the demand for goods and services. However, the disruption in the various supply chains and the lack of investment in some sectors contributed to an increase in inflation, which some Central Banks, strategists and managers came to consider as transitory, but which time has shown that we have gone late in recognizing that the inflationary problem was something more structural. The CPI was showing a changing panorama that led some countries to touch and even exceed 10% annual variation, increases not seen for more than 40 years.
Thus, bond yields rose in the US as the Federal Reserve took a much more aggressive stance to control that inflation. Bond markets tend to move ahead of equity markets, in anticipation of monetary policy moves.
While the benchmark 10-year US Treasury note yielded 1.5% at the end of 2021, the yield topped 3% in May. In June, the 10-year Treasury yield reached its highest level in 11 years, 3.485%, and at the end of September it was already at 3.8040%.
For its part, the ECB also began its restrictive monetary policy, resulting in a rise in the yield of the German bond to 2.109%, levels not seen in the last 10 years:
When yields go up, the prices of bonds already on the market go down. This is a function of supply and demand. When demand for bonds declines, new bond issuers must offer higher yields to attract buyers, driving down the value of lower-yielding bonds already on the market. This environment hit bondholders hard in the first months of the year.
Interest rates tend to follow long-term growth and inflation trends. Higher inflation usually means higher interest rates. However, when inflation rates rose throughout 2021, the bond market seemed to have a delayed reaction. A series of events, from continued supply constraints on major commodities to a major shift in monetary policy by the Federal Reserve (the Fed) and Russia’s invasion of Ukraine, altered the outlook for investors in 2022. .
Yield curve flattening
Another trend is the unusual interest rate environment along the yield curve that represents the different maturities of the bonds. Under normal circumstances, bonds with longer maturity dates yield more, which is known as an upward sloping yield curve. This statement reflects a yield premium for the greater uncertainty of lending money for a longer period of time. The year 2022 has been an unusual period in which yields across the maturity spectrum have narrowed, reflecting a “flattening” of the yield curve.
But there are some times where the returns of the different maturities are inverted, which means that the interest paid on short-term securities is greater than that offered on long-term maturities. These trends have historically been seen as indicators of below-average returns in the equity market, and therefore investors should take a defensive approach to the markets in the short term.
However, there is the possibility of finding opportunities in the bond market
According to a discussion table with the heads of several international managers in Spain, there are now opportunities in the fixed income market, with special emphasis on investment-grade corporate debt core bonds, as well as short-term government debt. Although seeing the following graph, why take credit risk when we have an attractive government bond market:
Samuel Edwards is the name you must have heard many times while reading reports related to Finance, that’s what he is good at. From Major Investments to Stock Market Updates, he got ’em all. Be ready to blow your mind by the mind-blowing reports of Finance World from Samuel Edwards.