Rate Expectations

Two months after the Super Bowl, there are thousands of people across the globe wearing shirts, hoodies, and hats declaring the Bengals Super Bowl LVI Champions. This is odd because Cincinnati ultimately lost 23-20 to the Rams in the final seconds of the game.

Every year, sports leagues have championship gear ready to display on the winning athletes and sell online mere seconds after the game ends. It’s big business to have the winner’s apparel ready to ship; It’s estimated MLB Shop sold $70 Million of Cubs gear a day after they won the 2016 World Series. It’s another story for the loser’s “championship” gear.

The bond market is no stranger to winning and losing predictions about interest rates. The global bond market is roughly $120 Trillion in size, so there’s a lot at stake in guessing future interest rates correctly. It’s also one of the most difficult markets to get right.

Owners of bonds or bond funds have just experienced an all-time sucker punch. Bonds recently had their worst quarter in 40 years, with Treasuries losing nearly 6%, and investment-grade corporate bonds losing 8% or more.

The market is suggesting traders’ interest rate expectations have shifted dramatically. Previously, The Fed had suggested there would be no interest rates hikes until 2023, but today the market is expecting 8 hikes in 2022 alone.

The Wall Street Journal notes: “As it stands, interest-rate derivatives show that investors now expect short-term rates to reach 3% next year—up from less than 0.5% now and near-zero before the Fed’s recent move.”

More rate hikes are likely on the horizon. It’s a seemingly difficult position to be in for bondholders, but remember the market often braces for impact long before the story becomes fact.

For example, during the GFC Stocks bottomed in 2009; a full two years before the housing market did. In March 2020 stocks quickly dropped 35%, but have doubled from those lows even though COVID-19 has continued disrupting our lives since then.

With investing, pain is often frontloaded. Worst-case scenarios get priced in first, and prices recover if or when they get ruled out.

It’s important to remember that the Fed only controls 1 aspect of the bond market- the overnight lending rate. Treasuries, corporates, mortgages, etc. are all controlled by traders who are looking for clues into the future.

This means it’s entirely possible the Fed could raise interest rates, but bond prices recover as well if rates rise slower than anticipated.

The good news for fixed-income investors is there’s no kneeling or running out the clock in the sport of investing. Individual bonds are designed to pay full value back at maturity, while bond funds can reinvest into new issues with higher yields to compensate investors. While occasionally volatile, bonds are often one of the safest investments available due to their principal guarantee.

Sporting seasons are different though; there’s no such guarantee for losing team apparel, as some 10,000-15,000 “championship” items end up written off as losses after each season finale. Although valueless, there is a feel-good aspect; The clothing ends up globally distributed by nonprofits like WorldVision or Good360 to people in need.