The first quarter of 2022 was one of the worst on record for the bond market.
Bond markets came under intense pressure during the first quarter, with all issues posting losses amid one of the worst quarters in recorded credit market history. At their March meeting, the Federal Reserve raised interest rates for the first time since 2018 and has indicated a series of additional rate increases through the remainder of 2022. The Fed has also stated they are likely to begin reducing (selling) their holdings of Treasury and mortgage-backed bonds in the very near future.
For the quarter, the yield on the benchmark 10-year Treasury bond rose from 1.52% to 2.32% – a big move. Of even greater potential significance is that the flattening of the yield curve that started late last year developed into a brief inversion of the yield curve when looking at the 10-2 Treasury Yield Spread as seen in the chart below. This led to many market pundits forecasting an impending recession.
Although the yield curve has briefly inverted in the past without leading to an actual recession, yield curve inversions have been a somewhat reliable indicator of recessions looking out over a one-to-two-year period. One of the easiest ways to think about the importance of the yield curve is to think about its impact on banks. It essentially measures a bank’s cost of money versus what it can make by lending it out or investing it over a longer period of time. If a bank can’t make money, lending slows and so does the economy.
As we noted in our Fourth Quarter 2021 Wealth Report, we saw a number of headwinds for bonds as we looked into 2022, not the least of which was persistently higher inflation rates. This was the case throughout the first quarter and currently shows no signs of dissipating. As a result, the Fed is becoming more aggressive in tightening monetary policy and the outlook for bonds continues to be a concern.
As of this writing, the yield curve inversion has reversed, but just barely with the spread between 10 and 2-year Treasuries currently sitting at 0.03%. As credit markets continue to be extremely challenging, our active approach to managing this asset class becomes even more important. At the same time, as yields continue to rise, it provides us the first opportunity in several years to lock in higher interest rates with new purchases. Time will tell if a recession ultimately develops, but our disciplined approach to managing multi-asset class portfolios has served our clients well through many difficult environments over the years.
