By Tom Burnett CFA
During the October 19, 2022, trading day, the major benchmark interest rates were trading at the highest level of the 2022 year. The Two-Year Treasury Note yielded 4.5%, while the Ten-Year Treasury Bond traded at 4.11%. At the end of 2021, the yield on the Ten-Year Bond was 1.51%. The Long Bond (20+years) is now yielding 4.12%, up from 1.91% at the end of 2021.
The primary cause of the higher rate environment is the well- publicized policy of the Federal Reserve to raise short-term rates, cool the economy and bring down inflation which is running at an 8% level, as defined by the Consumer Price Index. The Fed began raising rates in February when the Fed Funds rate was under 25 basis points, bringing the current range to 3-3.25% at the September meeting. Most observers now expect an additional increase of 75 basis points at the November 2, 2022, meeting.
The impact of the rate increases on the financial markets has been extremely negative for both bonds and stocks. The major stock market indexes are down between 25 and 32% this year and the bond market returns have been similarly affected. For example, the Bloomberg Long Term Corporate Index total return in 2022 is a negative 30.7%. Overseas markets are also showing negative returns as shown by the WSJ Global Government Index which is down 13.4% this year. The WSJ Index of Emerging Markets bonds is down 23.0% for the year.
Higher rates hurt corporate profitability since corporations are net borrowers and as the economy responds with reduced activity corporate profits will be under pressure. Stock market investors are also faced with more attractive alternative investments as fixed-income rates move to higher levels than stock market dividends provide. For example, the S-P 500 Index offers a dividend yield of 1.8%, appreciably lower than the 4.5% yield on the Two- Year Treasury Note.
With inflation continuing to run higher than the Fed’s stated goal of 2%, investors should expect additional Federal Reserve actions that will keep rates moving up until the Fed is satisfied that its actions have brought inflation down.
Tom Burnett CFA is Director of Research