Problems Brewing in Bond Market; Shocks Possible in 2022
For long-term investors, it’s important to assess risks on an ongoing basis. If investors know the risks, they can act accordingly and not be caught by surprise.
With this in mind, investors should pay close attention to the bond market. There are problems brewing. Given the size and impact of the bond market, there could be ripple effects across many assets. Investment portfolios could be hurt badly.
Why care about the bond market at all?
The bond market is huge. Pension funds, institutions, central banks, governments, and other big players are involved. Interest rates are dictated by the bond market, companies’ debt costs are dependent on the bond market, mortgage payments are highly correlated with the bond market, and so on and so forth.
As Inflations Soars, Will Bond Values Be Fine?
Now, digging into the details…
The bond market has one big enemy: inflation. When inflation soars, the bond market drops. This is mainly because, in times of inflation, central banks tend to raise their interest rates to fight it. This causes bond prices to decline.
How’s inflation looking at the moment? It’s getting worse, according to all measures—official and unofficial.
According to the U.S. Bureau of Labor Statistics, consumer inflation in the U.S. economy increased by 0.9% in October. Over the past 12 months, prices in the U.S. have increased by 6.2%. (Source: “Consumer Price Index Summary,” U.S. Bureau of Labor Statistics, November 10, 2021.)
Now, take a look at the chart below. It plots the yields of 10-year U.S. Treasuries.
When yields drop, it’s a sign that bond prices are jumping. When yields pop higher, it’s a sign that bond prices are dropping. Since August 2020, yields on 10-year U.S. Treasuries have surged by almost 180%. In other words, the bond market is spooked.
Chart courtesy of Stockcharts.com
Coming back to inflation, it’s likely that inflation will run much higher in 2022—at least in the first few quarters of the year. This is mainly because supply chain issues persist. Plus, there’s the recent emergence of a new COVID-19 variant, which could result in more economic restrictions. And that could make the global supply chain problems even worse.
Here’s the big question: If inflation surges in the coming months, will the Federal Reserve do anything?
For a while, the Federal Reserve was convinced that the higher-than-normal inflation would be transitory. But now, it’s becoming very clear that the transitory period is getting longer. Even the Fed seems somewhat ambiguous about when inflation pressures could ease. It’s possible that the Federal Reserve will be forced to do an emergency interest rate hike in 2022 to curb inflation.
Why a Shock in Bonds Could Cause Crashes Elsewhere
Dear reader, my goal isn’t to scare you. Rather, it’s to provide you with insights and analysis that you might not see in the mainstream financial media.
Inflation surging, the bond market being spooked, and the chance of the Federal Reserve raising interest rates in 2022 creates the possibility of a shock in the bond market. I’m talking about yields on 10-year U.S. treasuries jumping by more than 2.5%.
Don’t forget that everyone gets impacted by what happens in the bond market. We could see the stock market drop, home prices plunge, consumer spending get hurt, and the U.S. economy face a slowdown.
As such, you won’t want to ignore what happens with bonds. The bond market could be the place that creates the next wave of troubles for the financial world.