There are signs that global bond markets may bottom after central bank rate hikes

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There are signs that global bond markets may bottom after central bank rate hikes

Person reviewing financial charts on the phone

Fixed income investors are experiencing what may be the most challenging year for bond markets in 45 years, with 2022 just around the corner the worst since 1931.

Bonds are debt instruments issued by companies or governments that are converted into tradable assets. They contain the loan terms such as interest payment, loan amount and due date. Bonds essentially act as instruments that governments and companies use to borrow money. Although the stock market generates far more headlines, the global bond markets are by far larger than the stock markets $100 trillion tied up in bonds worldwide versus $64 trillion in stocks.

Investors generally charge higher interest rates to lend to governments for longer periods, reflecting the opportunity cost of keeping their money locked up for longer given rising growth and inflation forecasts. On the other hand, short-term interest rates occasionally rise above longer-term yields, disrupting the usual trend in bond markets. When the yield curve inverts, investors demand more interest to lend to the government for shorter periods. This anomaly implies that investors expect economic growth to slow down soon. Historically, an inverted yield curve was a strong indicator of an imminent recession. This is especially true when the US faces strong global headwinds from Europe, where the Russia-Ukraine War and the associated sanctions have triggered a painful energy price shock.

Many consider bonds to be safer alternatives to other investments, and government bonds are among the safest government bonds. While bonds are less volatile and tend to outperform stocks in tough economic times, that doesn’t mean they’re a rock-solid investment or that you should only invest in bonds.

Olive Invest aggregated information on bond markets from a variety of professional, expert and news sources to provide a clearer picture of US bond market performance.

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Interest rates continue to rise, but at a slower pace

United States Federal Reserve Bank building

Two years after the worst pandemic in a century, the global economy is still grappling with the ongoing impact of the COVID-19 pandemic on slowing economic growth and rising prices. The US in particular has been battling inflation since the economy rebounded from COVID-19-related shutdowns of industries and disrupted supply chains. To contain inflation, the Federal Reserve has used the tools at its disposal, most notably raising interest rates and the threat of more. Most recently, the Fed raised interest rates by 75 basis points. However, the punch-through effect on the bond market could lead to a bottoming out of bond prices.

At first glance, the connection between interest rates and bond prices may not be obvious. However, a closer look reveals that when central banks raise interest rates, bond prices fall, thereby ensuring that the face value of the bond remains constant. This is well known among prospective brokers studying for their studies Securities License Exams like the see-saw that compares bond prices and interest rates a seesaw in a children’s playground. Because of the inverse relationship between interest rates and bond prices, expect bond prices to continue falling as the Fed continues to hike rates.

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Equity market volatility, driven in part by risks from Europe, is prompting investors to seek safe havens such as government bonds

US savings bonds with American currency

Ideally, equity markets offer higher expected returns than bond markets. However, they also harbor higher risks of loss. The Fed’s aggressive rate hikes and the associated risks Defaults on emerging market bonds have combined with Factory holiday in connection with the energy crisis in Germany and other European manufacturers to scare investors. The result was a flight to safety, with institutional and retail investors turning to government bonds.

Lower bond prices are beginning to open up lucrative opportunities for investors looking for yield but security. Short term Instruments currently offer increasing returns at 4.48% for six months, 4.53% for one year and 4.41% for two years, while longer maturities such as the five- and ten-year bonds offer yields of 4.18% and 4.01%, respectively.

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Recession talks from business leaders and politicians are pushing stocks lower and likely sending bonds higher

Stock market chart and dollar bill

With the Fed maintaining its hawkish stance and Fed Chairman Jerome Powell hinting that it will continue to hike rates aggressively, industry pundits and investors fear it could push the US economy into recession.

The last time the Fed aggressively raised interest rates to curb inflation was under then-Fed Chairman Paul Volcker in the early 1980s. The Volcker Fed’s rate hikes made borrowing money and mortgage interest so expensive that Bank Certificates of Deposit were insured with the Federal Deposit Insurance Institution in May 1981 with 18%near the high water mark of the severe recession of 1981-82.

Regarding the current outlook, Fed officials have said they intend to continue raising interest rates well above current range of 3% to 3.25%, allowing analysts to speculate on how high rates could go. However, the costs of servicing government debt around the world have accumulated over the past 40 years G7 countriesincluding the US, would make any Fed rate hike approaching the rates Americans experienced in the early 1980s unbearable.

With interest rates rising faster than expected, the unexpected impact of quantitative tightening and the expected ongoing war in Ukraine are indicators analysts believe are likely to plunge the US economy into recession. Against this stark global backdrop, industry experts like JPMorgan Chase CEO Jamie Dimon believe the S&P 500 could suffer a painful downturn. A negative outlook for equity markets can, in turn, push investors back into bond markets, leading to higher bond prices.

This story originally appeared on Olive Invest and was produced and
distributed in partnership with Stacker Studio.

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