Rising Yields in Q1 Lead to Lowest Fixed Income Returns in Decades
Increasingly entrenched inflation, a more hawkish Federal Reserve, and a commodity shock driven by Russia’s invasion of Ukraine combined to make the first quarter of 2022 one of the lowest for fixed income in decades. The Bloomberg Municipal Index fell 6.23 percent in Q1, marking its worst quarterly total return since 1981. Global credit shed over $1 trillion in value, which Bloomberg notes is the steepest loss for investment grade bonds since Lehman Brothers’ collapse and the lowest return for high yield debt since the onset of the COVID-19 pandemic.
While total returns on major indices were falling, the policy-sensitive two-year Treasury note yield posted its biggest jump since 1984. Yields at every tenor were higher at the end of the quarter than where they started. However, rate increases were uneven, most clearly evidenced by the spread between the 10-year and two-year U.S. Treasury yields marching towards zero throughout the quarter, indicating an inversion at two key points in the yield curve and a portent of future recession. It took until early April for the inversion to happen, but it raised further alarm bells from an asset class already suffering a sharp drawdown.
Far from rejoicing at the higher yields on offer, these developments have precipitated outflows from fixed income funds, reflecting deep unease among bond investors, who have seen the supposedly safest part of their portfolio post losses as meaningful as 7.69 percent for U.S. investment grade corporates or worse if one held exclusively emerging markets debt. Entering the second quarter, sentiment is understandably and unambiguously negative for bonds. However, as Strategas Technical & Macro Research highlighted in a note dated April 4, “Of the eight yield curve inversions (2/10’s) over the last 40 years, 10-year yields have been lower 12 months later in six of those instances.”
Investors can hardly hope that their bond income will match inflation at current levels, but the flip side of poor price returns is higher income. The rise in yields in Q1 closed some of the gap between coupons and inflation, while bringing five- and 10-year Treasury yields closer to long-term resistance levels, which Strategas suggests could provide scope for a cyclical rebound in bond prices. None of this is to suggest that bond prices necessarily will rebound in the coming months, which are likely to be quite volatile, but it presents a potential entry point into an asset class that is suddenly yielding more.
Tasos Vossos, Hannah Benjamin, and Jack Pitcher, “ Global Corporate Bonds Lost $1 Trillion, and Risks Are Rising,” Bloomberg, March 30, 2022, https://www.bloomberg.com/news/articles/2022-03-30/corporate-bonds-lost-1-trillion-and-there-s-more-trouble-ahead
James Hirai and Kristine Aquino, “Bond Selloff Shows Little Sign of Ending as Fed Prepares to Hike,” Bloomberg, March 22, 2022, https://www.bloomberg.com/news/articles/2022-03-22/two-year-treasuries-face-worst-loss-in-38-years-on-hawkish-fed
“10-Year Treasury Constant Maturity Minus 2-Year Treasury Constant Maturity (T10Y2Y),” FRED Economic Data St. Louis Fed, April 8, 2021, https://fred.stlouisfed.org/series/T10Y2Y
“U.S. bond funds see money outflows for 10th straight week,” Reuters, March 18, 2022 https://www.reuters.com/business/us-bond-funds-see-money-outflows-10th-straight-week-2022-03-18/
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