I don’t think it comes as a surprise to anyone to hear that major shifts are happening in our country and economy. People are on the move. Industries are changing. Long-term trends seem to be playing out all at once. These shifts create lots of questions that are hard to answer, and the uncertainty can be uncomfortable, to say the least.
This impacts everyone and even flows over into the normally staid world of bonds. Recent months have seen the stock market rise but prices for bond benchmarks like the 10yr Treasury have fallen. The 10yr Treasury is important to follow because it serves as the benchmark for mortgages and is a good proxy for bond returns in your investment portfolio.
The yield on the 10yr is currently about 1.6%, up almost 1% from the lows of last Spring (as a reminder, yields rise when prices fall). The 10yr yield remained low until late-Summer when it began to rise again before falling prices accelerated in the last month or so. The result is that the average 30yr fixed rate mortgage is now over 3%, following many months below that, and typical bonds within your investment portfolio are probably down around 3% year-to-date. Longer-term Treasurys are down more, almost 12%, and short-term bonds are down too, maybe less than half a percent. This volatility follows strong returns for bonds over the past two years.
So why is this happening to the bond market now? In short, bond investors are struggling with big questions just like the rest of us. How quickly will our economy get back to normal? What will that even look like? How helpful will government stimulus programs be, and will they become problematic by causing inflation?
Bond investors have been reacting to these questions in recent weeks primarily by selling bonds. That selling, as I mentioned, causes yields to rise, mortgage rates to go up, and so forth. The primary culprit is said to be inflation fears. These fears appear to be warranted, at least if you look at things through a short-term lens.
Manufacturing is roaring back to life even as companies deal with material shortages, shipping delays, and higher commodity prices. And Congress seems poised to pass massive amounts of economic stimulus this week that will inject hundreds of billions of additional cash into the economy. Many market prognosticators are assuming that the coming rush of consumer spending could hit supply-constrained manufacturers and lead to, you guessed it, inflation.
An interesting aspect to this, however, is how the government agencies that are supposed to stay up nights worrying about inflation, simply aren’t. Or at least not in the way you might think.
In the past week or so we’ve heard Jerome Powell, the Fed chair, and his predecessor and current Secretary of the Treasury Janet Yellen, express a distinct lack of concern about inflation. The issue, they say, is that our economy is still reeling from the pandemic and has lots of room to absorb all the stimulus money. If you just look at recent months, yes, the economy is growing quickly, and some prices seem inflationary. But that’s growing from the bottom of a deep hole. Instead, if you broaden your comparison to pre-pandemic levels certain sectors of the economy are still struggling, and overall inflation is quite low, currently less than 2%.
Reasons for this come from many places but primarily we see it playing out in our country’s unemployment rate, which is 6% or so. According to Secretary Yellen, however, real unemployment is more like 12% if you define the term more broadly. The bigger picture unemployment rate was about 7% before Covid-19 hit our shores and rose to around 22% last Spring. Yes, 12% is much better than 22% but we still have a way to go before “full employment” is reached. And recent reports indicate that about 40% of the unemployed have been so for over half a year, the so-called long-term unemployed. That’s a lot of people who are losing touch with their respective industries, skillsets, and so forth. Essentially, both Powell and Yellen are staying up nights concerned about those people, not inflation.
Regarding current moves in the bond market, Powell and Yellen seem equally sanguine. The yield on the 10yr Treasury was about 3.2% a lifetime ago in late-2019, so they likely see the recent yield uptick to 1.6% as a step toward normal for bonds.
A takeaway from all this, I think, is that even though we had strong returns last year from stocks and bonds, this year, like we’ve discussed in other posts, is likely to be volatile. This is nothing new for the stock market, but you might be less used to it coming from the typically stable world of bonds. Modestly higher interest rates will take a little pain to reach but will be healthier for the economy in the long run. So, try to take recent bond market volatility in stride as part of an adjustment phase for bonds. Just one more aspect of our lives and economy searching for normal.
Have questions? Ask me. I can help.
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