January 2022

Summary:

  • If we only evaluate other rate hikes, current market volatility may continue until after the Fed’s first rate hike.
  • Although bond values and interest rates move inversely, owning bonds during a rising rate environment has not been horrible. In fact, during the most recent periods of rising rates, bonds have shown positive returns.

Market Returns
(YTD through 1-27-2022)

-9.16% S&P 500 Index (US stocks)

-5.64% MSCI EAFE (Int’l stocks)

-2.56% Bloomberg US
Aggregate Bond (US Bonds)

Historically, markets tend to react abruptly to changing interest rate expectations, which is the environment that exists today, while remaining calmer during the actual policy increases.

Part 1:  The Myth About Bonds

Many advisors and investors have been increasingly fearful of what rising interest rates may do to the bond market. After all, bond prices decline as rates increase, known as duration risk. While duration risk is very real, rates along the yield curve don’t always move in tandem.  Also, high quality bond yields are typically the best proxy for expected returns for bonds, so while there may be short term volatility, it can mean a better longer-term picture.

We examined two recent periods of Fed policy adjustments, the mid 2000s and mid 2010s, and found what may be counterintuitive to most investors. During each of these periods of policy rate and government yield increases, both the US bond and equity market1 produced positive total returns. In both cases, the Fed Funds Rate rose significantly, but the 10-year yield increased only slightly.

Dates Fed Funds
Rate		 US 10-Year
Treasury Yield		 Dates Fed Funds
Rate		 US 10-Year
Treasury Yield
6/29/04 1.00% 4.69% 12/13/16 0.25% 2.47%
6/29/06 5.25% 5.19% 12/19/18 2.25% 2.75%
730 Days +4.25 p.p. +0.51 p.p. 736 Days +2.00 p.p. +0.28 p.p.
Cumulative
Total
Returns		 6.06%
Bloomberg US
Aggregate		 16.22%
S&P 500		 3.78%
Bloomberg US
Aggregate		 14.85%
S&P 500

We get it.  No one is excited about bonds these days (neither are we).  BUT, they continue to serve an important role in risk management, inflation and yield delivery.  Don’t be in a huge rush to discount their value in favor of more volatile or complex alternatives.

Part 2:  Analysis of Market Action Prior to Rate Hikes

One Year Before and After the 2004 Rate Hike

  1. The six-month Treasury yield is a decent proxy for where the Fed Funds rate is headed.  Roughly three months prior to the first rate hike, the six month Treasury yield began to creep up.
  2. There was a drawdown in the S&P 500 and NASDAQ Composite indices that started several months prior to the rate hike and bottomed shortly after the first rate hike.
  3. The path of rate hikes tended to follow the path of the six-month yield and coincided with a flattening yield curve and positive equity moves.

One Year Before and After the 2015 Rate Hike

  1. The six-month Treasury yield is a decent proxy for where the Fed Funds rate is headed. Roughly three months prior to the rate hike, the six-month Treasury yield crept up. However, it dropped during the first equity selloff as expectations for the hike dropped with equity market volatility.
  2. The drawdown in the S&P 500 and NASDAQ Composite indices started several months prior to the rate hike and bottomed shortly after the first rate hike.
  3. The path of rate hikes tended to follow the path of the six-month yield and coincided with a flattening yield curve and positive equity moves, however at a much slower pace than 2004 to 2006.

One Year Before and After the Expected 2022 Rate Hike

  1. The six-month Treasury yield is a decent proxy for where the Fed Funds rate is headed. Roughly three months prior to the expected first rate hike, the six-month Treasury yield crept up.
  2. The current drawdown in the S&P 500 and NASDAQ Composite indices has been incredibly swift thus far and on the heels of a very strong equity market run-up.
  3. A major question that remains is will the Fed provide more dovish guidance if the selloff tames inflation concerns and impairs the employment picture.

Part 3:  The Bottomline

  1. The 6-month Treasury is a good proxy for the Fed Funds Rate. Roughly three months before the Fed raises rates it starts to move up.
  2. When that has happened, we’ve witnessed substantial market volatility (that’s what’s happening now).
  3. Historically, market volatility continued until shortly after that first rate hike.
  4. After the first rate hike, markets generally propel upward on the back of a strong economy.

Source: Helios Quantitative Research, Bloomberg
1 Source: Equity market represented by the S&P 500, bond market represented by the Bloomberg US Aggregative

Investment advisory services provided by NewEdge Advisors, LLC doing business as Tempus Advisory Group, as a registered Investment Adviser. NewEdge Advisors, LLC is a wholly owned subsidiary of NewEdge Capital Group, LLC.This information should not be duplicated or distributed unless an express written consent is obtained from Tempus Advisory Group in advance.  The views expressed here reflect the views of the Tempus Advisory Group Investment Committee as of 1-25-2022. These views may change as market or other conditions change. This information is not intended to provide investment advice and does not account for individual investor circumstances. Investment decisions should always be made based on an investor’s specific financial needs, objectives, goals, time horizon and risk tolerance. Past performance does not guarantee future results and no forecast should be considered a guarantee either.

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