2022 has been off to a rough start for investors. The three major asset classes: stocks, bonds, and cash have all posted negative real returns year-to-date. With inflation taking a 7.9% bite out of your purchasing power over the past year,1 and interest rates projected to move higher, it can feel like bonds in particular could be fated for even worse performance ahead. But what does the past tell us?
Minghze Yi, PhD and Researcher at Dimensional Fund Advisors tells us that, “even if the timing and direction of federal funds rate changes could be predicted perfectly, we would still not know for certain how other interest rates would react.” And Nobel prize winning economist, Eugene Fama showed that interest rate hikes by the Fed (which controls the overnight lending rate that commercial banks borrow and lend excess reserves to each other) had no conclusive impact on the long-term path of interest rates.2
In fact, looking at Exhibit 2 in this article by Dimensional Fund Advisors, we see that for USD bonds you saw an increase in term premiums over cash in the years following Federal Funds rate increases. European term premiums stayed flat, while Japan and the UK actually showed decreases in term premiums.
So, while the S&P U.S. Treasury Bond 1-3 Year Index is down 1.94% year-to-date, and the S&P U.S. Treasury Bond 10+ Year Index is down 9.25% year-to-date, and we still have a hawkish Fed trying to tame inflation, that doesn’t necessarily mean that bonds prices will continue to decline.
If you’d like to discuss your bond allocation feel free to schedule a meeting.
1Based on the US Consumer Price Index for All Urban Consumers (CPI-U, not seasonally adjusted) from the Bureau of Labor Statistics.
2Eugene F. Fama, “Does the Fed control interest rates?” The Review of Asset Pricing Studies 3.2 (2013): 180–199.