Signs global bond markets may fall after central bank interest rate hike

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Signs global bond markets may fall after central bank interest rate hike

People check financial charts on the phone

Fixed income investors are experiencing what could be the most challenging year for the bond market in 45 years, with 2022 becoming a possibility. the worst since 1931.

A bond is a unit of debt issued by a company or government that is converted into a tradable asset. It contains the terms of the loan, such as interest payments, bond principal, and maturity date. Bonds basically function as instruments that governments and corporations use to borrow money. Although the stock market generates more headlines, the global bond market is more valuable than the stock market, with more than $100 trillion tied up in bonds worldwide versus $64 trillion in equities.

Investors generally demand higher interest rates to lend to the government over extended periods, reflecting the opportunity cost of tying up their money for longer amid rising growth and inflation forecasts. On the other hand, short-term rates occasionally rise beyond long-term yields, disturbing the usual trend of the bond market. When the yield curve inverts, investors demand more interest to lend to the government over a shorter period. These abnormalities indicate that investors expect economic growth to slow down soon. Historically, the inverted yield curve has been a strong indicator of pending recession. This is especially true when the US faces strong global headwinds from Europe, where it is Russian-Ukrainian war and related sanctions have made the energy price shock painful.

Many consider bonds a safer alternative to other investments, and Treasury bonds are the safest government bonds. While bonds are less volatile and tend to outperform equities in times of economic hardship, this does not imply that it is a rock-solid investment or that you should only invest in bonds.

Olive Investments collect information about the bond market from various professionals, experts, and news sources to paint a clear picture of the performance of the US bond market.

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Interest rates continue to rise, but at a slower pace

Building of the Federal Reserve Bank of the United States

Two years into the worst pandemic in a century, the global economy is still struggling with the effects of the COVID-19 pandemic from reduced economic growth and rising prices. In particular, the US has been fighting inflation since the economy picked up after closing industries related to COVID-19 and disrupting supply chains. To curb inflation, the Federal Reserve has leveraged tools at its disposal, especially interest rate hikes and more threats. Most recently, the Fed raising interest rates by 75 basis points. However, the pass-through effect in the bond market can cause bond prices to fall.

At first glance, the relationship between interest rates and bond prices may not be apparent. But on closer inspection, it becomes clear that when the central bank raises interest rates, bond prices fall, ensuring the bond’s nominal value remains constant. It is known among future brokers to learn for them securities license examination as a teeter-totter, likening bond prices and interest rates teeter at the children’s playground. Because of the inverse relationship between interest rates and bond prices, further declines in bond prices can be expected as the Fed continues to raise interest rates.

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stock market volatility is driven in part by risks from Europe causing investors to seek safe havens like Treasury bonds.

United States savings bonds with American currency

Ideally, the equity market offers higher expected returns than the fixed-income market. However, they also carry a high risk of loss. The Fed’s aggressive rate hikes and the risk of emerging market bond defaults has been combined with factory furloughs related to the energy crisis in Germany and other European factories to spook investors. The result was a flight to safety, with institutional and individual investors turning to Treasury bonds.

lower bond prices have begun to present a lucrative opportunity for investors looking for yield but with safety. Short term instruments now offer rising yields at 4.48% for six months, 4.53% for one year, and 4.41% for two years, while long maturities like five and 10-year bonds offer yields of 4.18% and 4.01% respectively.

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Recession talk from business and political leaders pushed stocks lower, likely sending bonds higher

Stock market graphs and dollar bills

As the Fed maintains a hawkish stance and Fed Chairman Jerome Powell indicates it will continue to raise rates aggressively, industry experts and investors worry it could push the US economy into recession.

The last time the Fed raise interest rates aggressively to curb inflation it was during the early 1980s under then-Fed Chairman Paul Volcker. The Volcker Fed rate hikes made borrowing money and mortgage rates so expensive bank certificate of deposit insured by the Federal Deposit Insurance Corporation yielded 18% in May 1981near the high-water mark of the severe recession of 1981-82.

Regarding the current outlook, Fed officials have stated that they want to keep raising interest rates high current range from 3% to 3.25%, leaving analysts to speculate how much higher rates can return. However, the cost to service the government’s global debt burden has accrued over the last 40 years G7 countriesincluding the US, will make any Fed rate hike approaching those American interest rates witnessed in the early 1980s unbearable.

With interest rates rising faster than expected, the unanticipated impact of quantitative tightening and the expected prolonged war in Ukraine is an indicator that analysts believe the possibility of tipping the US economy into recession. Against this stark global backdrop, industry experts, such as JPMorgan Chase CEO Jamie Dimon, believe the S&P 500 could experience a painful downturn. A negative outlook for the equity market can drive investors, in turn, back to the fixed income market, resulting in higher bond prices.

This story originally appeared on Olive Investments and was produced with
distributed in partnership with Stacker Studio.

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