mybestright.blogg.se - Bond drawdown

July was the first CPI release of the year where economists over-estimated inflation. Year to date the CPI survey has underestimated headline CPI by 1 – 3 basis points in 5 out of 7 months, and underestimated PCE in 3 out of 7 months (see Table 2 and Figure 2). Unfortunately, in the opposite vein economists have consistently underestimated the monthly inflation prints. There’s an old joke that economists have successfully predicted nine out of the last five recessions. Economists–and Their Models–Have Been Consistently Wrong About Inflation Given the general tendency for spreads to increase with economic uncertainty. The challenge is that inflation expectations have not been a good predictor of future realized inflation.

How quickly will it come back down after it peaks, and to what level?Īn investor who knows the answers to these questions would have a much better view of when the right time is to consider adding duration to their fixed income portfolio.

Have we already hit the inflation peak?.

The two crucial questions investors looking at the inflation numbers and considering their impact on Fed action are: Remember that the same tools that are used to spur growth during a recession are also inflationary, and a sitting Fed chair that greatly admires Paul Volcker is all too wary of the 1970’s stagflation trap.įigure 1: US CPI Year-Over-Year Change vs. The hottest inflation in four decades (see Figure 1) is likely to impact the Fed’s response function to changes in financial conditions. However, inflation above 9% puts the proverbial fly in the ointment. Indeed, we are already seeing this happen several long duration Treasury ETFs have seen significant inflows since the Fed began raising rates in March 2022 and recession odds started to go up. In this “normal” world, an investor could add rate sensitivity to a portfolio by increasing duration to fixed income products that no spread risk, such as US Treasuries. The tools at the Fed’s disposal to fight recessions work by decreasing borrowing costs (i.e., lowering interest rates) to stimulate economic activity.

In the absence of inflation, recessions are normally viewed as bullish for rate-sensitive fixed income securities. US rates markets are at an inflection point: bond investors are trying to position their portfolios for an increasingly likely US recession while a hawkish Fed is raising rates and reducing its balance sheet. Note: Past performance is not indicative of future returns. TIPS (Bloomberg US Treasury Inflation Notes TR Index) Treasury (Bloomberg US Treasury Total Return Index) Corporate High Yield (Bloomberg US Corporate High Yield Total Return Index) MBS (Bloomberg US MBS Total Return Index) Aggregate (Bloomberg US Agg Total Return Index)Įuro-Aggregate (Bloomberg Euro Aggregate Corporate Total Return Index)Īsian-Pacific Aggregate (Bloomberg Asian-Pacific Aggregate Total Return Index)ĮM USD Aggregate (Bloomberg EM USD Aggregate Total Return Index)Ĭorporate (Bloomberg US Corporate Total Return Index) Table 1 : 1H22 Fixed Income Asset Performance Index Name But as we’ll see below we may not be out of the woods yet, and it may be wise for investors to proceed with caution.

After a July 2022 stock and bond rally, followed by another sell-off, some investors may be tempted to “buy the dip” in bonds and take on more duration in hopes that the Fed achieves a swift victory over inflation and can soon pivot to a more dovish posture. Bond investors learned this painful lesson in the first half of 2022, with the largest bond drawdown in a generation delivering double-digit punishment almost across the board (see Table 1). However, the opposite is also true, with rate increases leading to bigger price losses as bonds sell off. Taking on more duration in a portfolio will lead to higher price appreciation if rates move down. Duration is a measure of a bond’s sensitivity to changes in interest rates. Fixed income investors that wagered on a bond rally were rewarded in July for extending duration in their portfolios. A few months ago a handful of economists were calling the inflation top, and some investors started betting on rate cuts in 2023.