Treasury Yields Rising—Will 2022 Be A Tough Year for Bond Investors?
The 10-year Treasury yield kicked off the new year by jumping more than 24 basis points in the first few trading days of 2022. It has a yield of about 1.655% compared to its 1.51% yield on December 31, 2021,[1] and the recent spike has the financial media buzzing. Most analysts now predict the 10-year Treasury could breach 2% this year.
Many wonder: Will 2022 be another tough year for bond funds?
Remember, bond prices and yields are inversely correlated, in that as bond prices fall, yields rise—and vice versa. In other words, as the 10-year Treasury yield rises, bond prices are falling.
So, why is demand for Treasuries tapering right now? A few factors are impacting the bond market today. In my opinion, a more confident American investor, inflation, and a slightly hawkish Federal Reserve all play a role.
First, the 10-year Treasury yield is often viewed as a barometer of investor confidence. At the height of the COVID-19 pandemic in early 2020, confidence was low, and Wall Street poured money into safer investments. As a result, the 10-year Treasury yield plunged below 1% in March 2020 and remained below this level until January 2021.
Wall Street was a bit more optimistic at the start of 2021, as many countries eased pandemic restrictions and life started returning to normal. Coincidentally, the 10-year Treasury yield spiked to 1.75% in the first half of 2021. That crushed many bond funds, including the popular iShares 20+ Year Treasury Bond ETF (TLT).
TLT reached an all-time high in late July 2020, but as Treasury yields started to rise in the second half of the year, TLT took it on the chin. The ETF declined nearly 23% during the following eight months. Some of those losses were recovered late in 2021 when Treasury yields moderated. With Treasury yields climbing again at the start of 2022, TLT has slipped lower.
Folks are naturally more optimistic at the start of a new year, and maybe that’s the reason for the recent strength in Treasury yields. We’ll see how this holds as we start getting economic data over the coming weeks. Wall Street will be laser-focused on the latest inflation data and will get a glimpse at how inflation is trending when the Consumer Price Index (CPI) and Producer Price Index (PPI) are reported this week.
Inflation has undoubtedly been top of mind for most Americans, as prices at the pump, grocery store—practically everywhere!—surged to decade-highs. In our December 29 article, Real Inflation – Why It May Be Higher Than the Headline Number, we discussed how consumers feel the pinch of rising prices and how our central bank is finally taking steps to combat inflation.
We are glad the Fed finally admitted inflation is no longer transitory and are pleased they announced plans to start aggressively tapering quantitative easing. In November and December, the Fed tapered by $15 billion per month and $30 billion per month, respectively. This month, the Fed will only buy $60 billion of bonds, or half of its previous $120 billion per month purchases. Central bank officials aim to wrap up the bond-buying program in March.
After that, the Fed plans to start raising key interest rates. Many Fed officials anticipate three rate hikes in 2022 and another two in 2023. We need to remember that the U.S. economy is still on shaky ground and far from out of the woods yet. So, these rate hikes bear watching.
For now, the Fed’s slightly hawkish stance and its plans to taper have been viewed as a positive, a vote of confidence on the U.S. economy. Some analysts estimate the 10-year Treasury could reach 2% or higher by the end of this year if the U.S. economy continues to recover.
In this environment, we feel bond funds are likely to underperform. We have repeatedly discussed with you our concerns about bond funds.
You need to remember there’s a difference between individual bonds and bond funds. Individual bonds can be held to maturity, while bond funds must be sold to get at the principal. In a period of rising interest rates, bond funds are far less attractive investments.
If you’re reviewing your portfolio, please give us a call at Nicollet Investment Management today. We’d be happy to review your current portfolio and help you assess the individual bonds that are the right investment for you.
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[1] https://www.marketwatch.com/investing/bond/tmubmusd10y?countrycode=bx
Reference Articles
https://russellinvestments.com/us/blog/treasury-yields-rise-2022
https://www.investopedia.com/articles/investing/100814/why-10-year-us-treasury-rates-matter.asp