2022 has not started off smoothly in financial markets. Many factors have combined to produce volatility across all asset classes. The surge in inflation, driven by supply chain issues and the reopening of the economy, sent bonds into a selloff. Bond prices move in the opposite direction from yields, so bond interest rates have been moving up.
Inflation also rattled the stock market, which had been enjoying a bull run since the selloff in March of 2020. Inflation and rising interest rates can affect a company’s borrowing costs, which makes it especially dangerous to young companies like tech firms. Tech had been the darling of many investors for the past two years, so the selloff in that sector had some running for the exits.
The Federal Reserve now has its work cut out for it. The hope is to control inflation without causing a recession, though historically they have not been able to pull this off. Inflation pressures may ease on their own as we get further from the economic shutdown of 2020, but no one is willing to bet the farm on that. The Fed has discussed the possibility of a half-point hike rather than the more traditional quarter-point, or possibly hiking rates in between meetings.
The best bet for the Fed is to make an aggressive half-point rate hike which would buy them time to see the impact of that hike and watch the other inflationary pressures. You can read more about the Fed and its plans here.
Rising interest rates is something we have been waiting on for quite some time. While the surge in inflation is not ideal for any investors, we expect it will be shorter term – in the two year timeframe. But the benefits of interest rates going up will remain. As long-term bond investors, we benefit most at the edges of the business cycle. That is, when interest rates hit their bottom or their top. Rising rates create buying opportunities in the mortgage-backed bond market – something we have been missing as we sat at the low end of rates for so long.
While we can expect volatility and uncertainty in all asset classes for the rest of the year, we welcome this return to what will hopefully be a more normal business and interest rate cycle.
