2022 was the worst year of performance in 97 years for the bond market, ending the year -13.07% as measured by the Bloomberg U.S. Aggregate Float Adjusted Index. Equity markets did not fair much better with the most comprehensive view of the U.S. equity market, the Wilshire 5000 -19.00%.
The Federal Open Market Committee increased the federal funds rate from around zero to 4.25% to 4.50% in an attempt to reign in inflation. With an additional two increases this year the overnight rate now sits at 4.75% to 5.00%. Changes in the fed funds rate triggers a chain of events that effect short and long term rates as well as many other variables throughout the economy.
The Feds hawkish stance impacted the 10-year treasury or risk free rate as it more than doubled, ending 2022 at 3.88% after starting the year at 1.63%. The 10-year was 3.42% at todays close. Interest rates and bond prices have an inverse relationship meaning increases in interest rates cause the value of bonds to decrease, while rate decreases cause bond values to increase.
30-year mortgage rates hit historic lows diving to 2.66% in 2020, fueling the real estate market by decreasing borrowing costs and boosting home values. At the close of 2022 rates were 6.42%, up from 3.22% at the years start.
Some define recession as two consecutive quarters of negative Gross Domestic Product (GDP) growth. According to U.S. Bureau of Economic Analysis data the first half of both 2020 and 2022 were recessionary by that definition, though we continue to see slow growth over the longer term.
When short term Treasury rates exceed long term rates the result is an inverted yield curve which is often used by economists and portfolio managers alike as an indicator a recession is to come. Federal Reserve Board of Governors Chair Jerome Powell has directed investors to focus on short term rate spreads to measure recession risk. The 3-month bill and 2-year note inversion may hold a strong correlation to recessionary periods.
Recent bank failures of Signature, Silicon Valley and Credit Suisse and fear of contagion may force the Fed to slow rate increases in the near term. In a 2021 article published in the Financial Times Federal Reserve Bank of Minneapolis President and CEO Neel Kashkari expressed the need for “banks to increase their equity funding to protect against the next shock.” It should be noted he made no suggestion of a return to the gold standard.
The 2020 policy shift to fractional reserve banking and the Fed considering the launch of a central bank digital currency make any prediction of what the future holds for our banking system and economy as good as my own.
Will unemployment rates stay at their current levels?
Will wage growth continue its upward trend?
Can the Fed tame inflation and avoid pushing the U.S. economy into a recession?