Thursday, April 18, 2024

The U.S. Treasury market just suffered its worst-ever annual loss in 2022

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The US Treasury market notched a record annual loss in 2022, fueled by inflation pressures that prompted the Federal Reserve to hike its overnight benchmark by more than four percentage points.

Yields peaked in October or November, then retreated as inflation gauges began to show moderation and Fed officials slowed the pace of policy tightening. The yield curve inverted, with rates for 5-year notes first exceeding those for 30-year securities in March, while the gap between two- and 10-year yields also flipped.

Ultimately, these inversions reached historic extremes, signifying that investors expect high short-term yields to do economic damage. The inversion of the two- to 10-year curve hit as much as 85.2 basis points on Dec. 7, before ending the year at around 56 basis points. The five-year premium over the 30-year rate at one point reached as much as 46.8 basis points.

For 2023, many US interest-rate strategists expect Treasuries will extend their recent rally, dragging yields lower and steepening the curve in the second half of the year so long as labor-market conditions soften and inflation ebbs further.

  • The Bloomberg US Treasury Index returned -12.5%, its second straight full-year loss and the biggest in its four-decade history; the worst months for the index were in September (-3.45%), March (-3.11%) and April (-3.10%); the 1Q loss of 5.58% was the biggest on record for a single quarter
  • 2022 changes for benchmark yields:
    • 2Y +369bp
    • 5Y +274bp
    • 10Y +236bp
    • 30Y +206bp
  • Yields climbed as the likely course of the Fed’s policy rate was continuously reassessed, both before and after the central bank began hiking rates
    • In January, swap contracts referencing Fed meeting dates priced in four quarter-point rate increases over the course of the year
    • The central bank’s first move took place in March, when officials lifted the benchmark range to 0.25%-0.5%, a quarter point above where it had been
    • By April, half-point increases were priced in for the subsequent four meetings
    • In June, when the Fed did its first three-quarter-point rate increase since 1994, the market had begun to price in a drop in rates from the eventual peak
    • By December, when Fed policy makers published new forecasts with a median of 5.125% for the funds rate in 2023, market-implied expectations for eventual peak had declined to under 5% from highs around 5.25%
  • Russia’s invasion of Ukraine in February arrested the selloff temporarily, but it resumed as the price of crude oil jumped to the highest level in more than a decade, presaging higher gasoline prices; agricultural commodity costs also soared
    • By the end of the year, commodity prices had broadly returned to February levels, with oil and gasoline futures reaching year-to-date lows in December
  • US inflation accelerated in the first half, with the Consumer Price Index peaking at 9.1% year-on-year in June, ebbing to 7.1% by November; core inflation peaked at 6.6% in September and eased to 6%
  • Five-year inflation expectations implied by yields on Treasury inflation-protected securities peaked in March at more than 3.7%, and retreated to about 2.38% by year-end
  • During the second half of the year, Treasury yields were propelled past their June highs as UK and euro-zone yields began to soar, reflecting elevated expectations for where central banks in those economies might need to take their policy rates
    • In September, proposed tax cuts by a new British government caused a moonshot in UK yields that also hurt sovereign bonds globally until the plan was withdrawn and there was another leadership change
    • Treasuries also were buffeted by surprise moves during the second half of the year by the Bank of Canada — which did a bigger-than-expected 100bp hike in July and a smaller-than-expected 50bp increase in October — and the Bank of Japan, which widened the trading band for 10-year yields in December, sparking a selloff in Japanese government bonds
  • As losses mounted, large daily swings in yield became more frequent, and gauges of volatility and liquidity reached extreme levels
  • Some of the biggest daily changes in yield occurred on:
    • Feb. 28, a rally sparked by haven demand in the wake of sanctions on Russia, aided by month-end buying
    • March 2, a selloff after Fed Chair Jerome Powell backed 50bp rate hikes if needed
    • June 13, a selloff that was part of the ongoing market fallout from May CPI data released June 10
    • June 15, a rally after Powell downplayed outlook for a 100bp rate hike
    • Sept. 26, a selloff led by UK bond collapse
    • Sept. 28, a rally led by UK bonds after Bank of England intervention to arrest yield surge
    • Oct. 3, a rally led by UK bonds, aided by ISM manufacturing gauge
    • Nov. 10, a rally sparked by October inflation data
  • The Fed in June stopped reinvesting all of the maturing Treasuries on its balance sheet in June according to plans announced in May
  • The Treasury Department continued to reduce coupon auction sizes during the year, until November, when it said they had reached sustainable levels

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