The Federal Reserve (the Fed) remained relentless in their battle against inflation – during the 1st quarter of 2023, they raised the Fed Funds Rate an additional 0.25% to 4.75%. They have also hinted at a high probability that they will increase rates one more time in May despite the bank collapses and cooling inflation. However, the Fed Funds futures are anticipating a pivot and two potential rate cuts by year end.
In prior bulletins, I have brought up the discrepancy between domestic interest rates and foreign interest rates. This discrepancy amplified during the beginning of 2022 with the Fed being much quicker to raise interest rates than any other central bank. With the concern of global inflation still high, many of these central banks have finally started to increase their rates, following in the Fed’s footsteps. This has helped increase the ratios slightly, but U.S. interest rates remain higher than most other developed markets. For instance, in the 1st quarter of 2022, the U.S. 10-year Treasury was approximately 1.94% while the 10-year German Bund was only at 0.49%. Today, the 10-year rate is closer to 3.50% while the 10-year Bund is yielding approximately 2.40%.
The Fed’s decision to raise the Fed Funds Rate pushed short-term Treasury Bills higher with most sitting above 5% now. While short-term treasuries rates rose, bond investors’ fear of an economic slow-down outweighed their inflationary concerns and pushed the long end of the Treasury Yield Curve lower. Both the 10-year Treasury and 2-year Treasury rates decreased in the 1st quarter: the 2-year went from 4.42% to 4.03% and the 10-year went from 3.47% to 3.87%. This parallel move kept the curve inversion at a relatively steep level – currently -0.56% compared to the -0.55% difference we saw at year end.
This decrease in interest rates was a nice reprieve from the large increases to rates investors saw in 2022. For the full year 2022, the Bloomberg Barclays Aggregate returned -13% to investors. The decrease in interest rates in the 1st quarter (and consequently, increase in bond prices) led to a positive return of 2.96% giving bond investors reason to cheer. We continue to monitor current inflationary concerns as well as anticipated Fed Fund Rate targets to find bond investment opportunities. We have begun to increase our exposure to high-quality short-term bonds and move some money away from stocks and alternatives based on the concerns of a potentially weakening economy.