Evening Brief – 06.22.23

In 2022, the bond market had a massive meltdown as the Federal Reserve aggressively hiked interest rates to combat inflation. Many investors believed that purchasing stocks rather than bonds was the better investment because bond yields provided little to no returns.

What a difference a year makes.

While the equity markets have had an impressive run since the October 2022 lows, bonds are again becoming a strong consideration in one’s portfolio. Investors can now purchase high quality government bonds that will pay 5.75% for the next ten years, a 5-year Treasury note at roughly 4%, or a 3-month Treasury bill with an effective yield of 5.14%, all much better returns than the near-zero yields investors had to contend with over the last decade.

Meanwhile, there is mounting evidence in economic data that inflation has peaked, and the Federal Reserve is likely near the end of its tightening cycle. While Fed Chair Powell largely hinted at two more rate hikes this year in testimony before Congress on Tuesday and Wednesday, it is widely expected it will mark the end of the campaign. This should support an environment of lower rates as we head into 2024.

The 30-year Treasury yielded roughly 3% a year ago, compared with 3.85% now. The benchmark iShares 20+ Year Bond ETF (TLT) was around $118 at the time, and it is presently around $102. If the 30-year yield returns to 3%, TLT shares should return around 15% from current levels, provided the Fed’s inflation war is successful.

Of course, if one believes interest rates are still headed higher then owning paper at the short end and riding the curve into higher future yields makes sense.

But under the current economic environment, whether it’s the deeply inverted yield curve, inflation receding (not good for a higher rates argument), a softening labor market, as evidenced by rising jobless claims, or several other indicators pointing at a slowdown, and the near-end of monetary policy tightening, then it all makes a strong case to lock in rates at current levels.