Bye Bye TINA, We’re Glad to See You Go.
BY: ANDREW J. WILLMS
PRESIDENT AND CEO, The Milwaukee Company
2022 was a particularly tough one for stock and bond investors alike. Both asset classes suffered major price declines, something that has only happened three times previously (with a near miss in 2018).
There were a host of reasons for the stock market’s struggles last year, including:
- Recession worries
- A global supply chain crisis
- Russia’s invasion of Ukraine
- China’s excessive Covid-19 lockdowns
- The collapse of the FTX crypto exchange
The bond market’s woes, on the other hand, were largely attributed to a single cause – the Federal Reserve’s decision to dramatically raise interest rates in an effort to cool an overheated economy, and thereby bring inflation under control.
We have not seen bond yields as high as they are today for many years, marking a dramatic reversal from the financial crisis more than a decade. The return on fixed income investments plummeted in 2008, when the Fed cut the federal-funds rate to zero and purchased massive amounts of Treasury bonds, in an effort to combat the Great Recession.
With inflation rates at or below its’ 2% target rates, America’s central bank kept its primary policy rate near zero for the next 5 years, and then inched rates slightly higher, topping off at 2.4% in July of 2019. But the Covid-19 pandemic led to another round of “quantitative easing”, which, when combined with massive Congressional spending, led to a surge in inflation[1] last year.
Federal Reserve Chairman Jerome Powell assured investors that surging prices would be temporary. Unfortunately, he was wrong. As a result, America’s central bank is being forced to once again raise rates; this time at a historic clip.
Rising interest rates cause the market value of outstanding bonds with fixed interest rates to fall because newly issued bonds carry a higher interest rate. As a result, the market price of outstanding bonds declines in order to entice investors to accept the lower rate on the original coupon and thereby make older bonds competitive with newer, higher-yielding securities.
While rising rates lowers the market price of an outstanding bond, the interest payments received and proceeds collected when the bond matures is unaffected in absolute terms. Accordingly, if the bond is held until it matures (and the party that issued the bond does not default), the bond owner will receive exactly what he or she expected to collect when the bond was purchased.[2]
Moreover, there is a significant upside to rising rates for bond investors: the higher yields that they will receive going forward on new bonds they buy. For example, a 2-year Treasury bond yielded just 0.78% at the start of 2022. At year’s end, the rate had risen to 4.41%
The recent increase in interest rates have made bonds more competitive with stocks, and have led to some new acronyms surfacing. The acronym TINA – which stands for “There Is No Alternative” – is being replaced by TIAA, which stands for “There Is An Alternative” and CINDY for “Credit Is Now Delivering Yield”.
How long the renewed interest in fixed income investments will last is uncertain. Chairman Powell has consistently said the Fed will continue to hike rates until inflation has been tamed. Deciding what exactly will determine “tamed” inflation is an ongoing debate. For now, at least, the “mission accomplished” moment lies somewhere in the future. “Despite some promising developments, we have a long way to go in restoring price stability” the Fed chairman said recently.
If Mr. Powell remains steadfast this time around and keeps interest rates relatively high, bonds may be an attractive alternative to stocks for some time to come.
[1] Too much money + Too few goods = Inflation
[2] The same cannot be said for most bond funds, because they typically do not have a maturity date.