The main culprit, of course, is inflation. Soaring prices throughout 2022 prompted the Fed to aggressively raise interest rates—putting major downward pressure on bond prices while also fueling recession fears that sent stock investors heading to the exits.
But this wasn’t the first time we’ve seen surging inflation and a hard-charging Fed response. The unprecedented one-two punch raises the question: Why was it so bad this year—particularly for bonds?
One factor was just how comfortable investors have become with a low-inflation environment. Consider that inflation ran at an annualized rate of just 1.78%1 during the ten years through 2019. The shock of 9% year-over-year inflation earlier this year was an especially harsh reminder for many that prices can—and do—soar.
Additionally, bond yields entered 2022 near their lowest levels in decades (just 1.75%1), while bond duration (which measures bonds’ sensitivity to interest rate changes) was at an all-time high. In effect, bond portfolios were positioned to get hammered if interest rates rose sharply—which is exactly what happened, of course—with virtually no yield to help cushion the blow.
Barring a year-end rally, it looks like 2022 will likely be one for the history books.
1 Source: Bloomberg
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