By Tom Burnett CFA
On December 15, 2021, the Federal Reserve made it clear that it would be moving to a less accommodative approach to monetary policy. The Fed will be cutting its bond purchase program from $120 billion per month to zero in the March-April timeframe. If conditions warrant, the Fed will change course and re-adopt the monthly purchases. Rates will be increased at least three times by the Fed in 2022 with the average Fed Funds rate climbing to 0.9% from the current range of 0-0.25%. Further increases are expected as the Fed now estimates that the average Fed Funds rate in 2023 will be 1.6%. In spite of this straightforward presentation of expected future policies, the bond market reaction has been muted. The 30-year Treasury bond yield is currently trading at 1.86%, barely moving from the level when the Fed announcements were released. The reaction of the 10-year bond is even harder to explain as the yield has moved lower to the 1.42% level from 1.46% during the Fed announcement. These events were reinforced this morning when the Bank of England announced that it was raising the UK equivalent of the Fed Funds rate.
So far in 2021, stocks have far outpaced bonds. Using data from the December 16, 2021 Wall Street Journal, the comparative performance return differences are stark. The S/P 500 Index is up 25.4% and the Dow Jones Industrial Avg. is up 17.4% in 2021. In contrast, the Muni Bond Index return is flat, International Bonds are down 2.1%, Investment Grade Bonds are down 3.7%, 20+ year Treasury Bonds are down 5.4%, and Emerging Market Bonds are down 6.0%. The recent Fed actions will likely move rates higher which will increase the attractiveness of non-equity investments and could put pressure on the stock market returns. Right now, investors must deal with rate movements on the 10-year Treasury Bond which currently defy logic.
Tom Burnett CFA is Director of Research