In the past 50 years, negative bond returns have been infrequent and relatively small. Out of the previous 47 calendar years, negative returns only occurred in 5 instances, and the maximum decline was around -5%. However, this trend was shattered last year when the bond market experienced its worst performance since the French Revolution, with a jaw-dropping decline of 13%. Following this challenging period for bond traders, it is likely that the market will rebound in 2023. Fixed-income investments are expected to generate returns closer to their historical average of approximately 6.6%. This outlook is auspicious if the highly probable scenario of rate cuts materializes this year.
The Federal Reserve implemented an aggressive interest rate policy, leading to a cumulative increase of 5.00% in the Fed funds rate from March 2022 to May 2023, aimed at controlling inflation. As we approach the end of the hiking cycle, the most recent data on inflation indicates a consistent slowdown for the past ten months. This can be attributed to the delayed impact of reducing the money supply and raising interest rates, which has started to affect various inflation indicators. In June 2022, the year-over-year inflation reached its peak at 9.1%. However, it has since declined to 4.9%, which is still significantly higher than the Federal Reserve’s target inflation rate of 2% annually. Despite this, following its latest meeting, the central bank hinted at a possible pause in rate hikes, stating that it will closely monitor incoming information and assess its implications for monetary policy.
What happens to bonds if interest rates drop?
When interest rates fall, bond prices typically rise, and there may be an opportunity to profit if an investor sells the bond before maturity. For instance, if rates drop 1%, previously issued bonds are more attractive than current ones, as debt issuers will take full advantage of the now lower rates, so investors would be willing to pay a premium — above the par value — for those bonds. If an investor sells when the bond is trading at a premium, they can profit from the capital appreciation and the income earned up to that point on the bond.
Let’s look at the long end of the yield curve or the “TLT” (20+ Year Treasury Bond ETF); given the incredible drop over the last two years, bottoming at the -2 standard deviations line, it still looks undervalued, trading over one standard deviation, below its mean value of 126.
The bond market expects rate cuts based on the 2-year treasury securities, which have been reliable predictors of Fed rate movements since the mid-90s. This anticipation is driven by the possibility of a recession or a hard landing triggered by a credit event indicated by the inverted yield curve. As the hiking cycle nears its end, a pause will likely be followed by rate cuts. The banking system faces high contagion risks, and the economy cannot sustain the current rate trajectory. Therefore, rate cuts are seen as necessary to address these concerns and support stability.
Bonds and rate cuts
Market participants’ highly anticipated rate cuts will be positive for
fixed income once they materialize. The long end of the yield curve is
where investors want to be. In the past, 30-year treasuries outperformed
90% of the time, averaging over 7% returns in the 3 and 6 months post-last
Violeta è entrata a far parte di Leverage Shares nel settembre 2022. È responsabile dello svolgimento di analisi tecniche e ricerche macroeconomiche ed azionarie, fornendo pregiate informazioni per aiutare a definire le strategie di investimento per i clienti.
Prima di cominciare con LS, Violeta ha lavorato presso diverse società di investimento di alto profilo in Australia, come Tollhurst e Morgans Financial, dove ha trascorso gli ultimi 12 anni della sua carriera.
Violeta è un tecnico di mercato certificato dall’Australian Technical Analysts Association e ha conseguito un diploma post-laurea in finanza applicata e investimenti presso Kaplan Professional (FINSIA), Australia, dove è stata docente per diversi anni.
Julian è entrato a far parte di Leverage Shares nel 2018 come parte della prima espansione della società in Europa orientale. È responsabile della progettazione di strategie di marketing e della promozione della notorietà del marchio.
Oktay è entrato a far parte di Leverage Shares alla fine del 2019. È responsabile della crescita aziendale, mantenendo relazioni chiave e sviluppando attività di vendita nei mercati di lingua inglese.
È entrato in LS da UniCredit, dove è stato responsabile delle relazioni aziendali per le multinazionali. La sua precedente esperienza è in finanza aziendale e amministrazione di fondi in società come IBM Bulgaria e DeGiro / FundShare.
Oktay ha conseguito una laurea in Finanza e contabilità ed un certificato post-laurea in Imprenditoria presso il Babson College. Ha ottenuto anche la certificazione CFA.