Focus On Bonds

"Worst Drawdown on Record" For Global Bonds: Why The Fed Can't Help

The market sets interest rates, and the Fed follows

GAINESVILLE, Ga., March 29, 2022 /PRNewswire/ — Bloomberg recently reported that global bond markets have suffered unprecedented losses since their peak last year, wiping out $2.6 trillion in market value. Macroeconomics 101 teaches that the Federal Reserve controls interest rates in the economy, so is the Fed coming to the rescue?

That’s unlikely according to analysts at Elliott Wave International who say the Fed is simply at the mercy of the market. They observe that the Fed’s federal funds rate tends to follow trends in the freely traded bond market.

“The market sets interest rates, and the Fed follows,” said Murray Gunn, EWI’s head of global research. “They are reactive, not proactive.”

Preparing For The Ramifications Of Rising Rates

The Fed’s most recent move—a quarter-point increase in its federal funds rate target—adheres to this script. Rates began moving higher in parts of the bond market in 2020. By the beginning of this year, rates even on the short end of the yield curve had joined the trend. The Fed’s decision to increase the federal funds rate earlier this month, therefore, merely followed the rises in market rates.

But Gunn says there is one thing that Macroeconomics 101 gets right about bonds: rising interest rates mean falling bond prices. Thus, the giant drawdown that traders have faced recently.

Gunn counsels that instead of looking for a central bank savior, traders and borrowers alike would be better served preparing for the ramifications of rising rates. Consider the 2-year note. On February 5, 2021, it yielded 0.105%. Today the rate is near 2.3%. That’s a nearly 22-fold increase in just over a year.

Interest rates are going up no matter what. The Federal Reserve is just along for the ride like everyone else. There's no cavalry coming...

In dollars-and-cents terms, $1 billion borrowed at 0.105% would cost about $1 million in annual interest. But at today’s rates, the same loan costs nearly $23 million per year.

“Imagine if a company were facing such a huge increase,” said Gunn. “The additional money required to service the loan must come from somewhere. We’re talking the potential for smaller bonuses, lower salaries, fewer perks. And in some cases, all of those still won’t address the issue.”

There’s No Cavalry Coming

For its part, EWI warned subscribers in August 2020, “rising interest rates will suck money out of every investment account, bank account and mattress, and the race for cash will be on.” The firm’s October 2020 issue of The Elliott Wave Theorist showed a 78-year history of interest rates as measured by the yield on the 10-year Treasury note.

EWI told subscribers at the time, “Interest rates likely bottomed in March [2020], which means bond prices have begun a significant fall.”

Gunn underscores that point today, “Interest rates are going up no matter what. The Federal Reserve is just along for the ride like everyone else. There’s no cavalry coming.”

More information about EWI’s financial market analysis can be found on the firm’s website.