I wrote about interest rates back at the end of October titled, “Timing is Everything! In it, I reviewed the current Fed tightening cycle and how difficult it is to forecast interest rates, mostly due to the difficulty in understanding the timing lags implicit in every Fed action.
From the end of October (when I wrote that blog post) to now we have seen a dramatic swing in market interest rates! Through July 2023, we had just seen 18 months of rate increases from the Fed causing short interest rates to rise precipitously from 0.25% to 5.50% and 10-year Treasury rates increase from 2.19% to 3.96% (see chart below). Somewhat concurrently, the economy had started to show signs of slowing, thus prompting a thought that the Fed may be ready to end its tightening cycle to help quell inflation. Surely, a good time to lengthen duration! NOT!
From August through mid-October the Fed skipped any more rate hikes while 10-year Treasury rates jumped to peak at 4.98%! Though the causation is not clear, some economic statistics showed some strength that probably prompted fear of a resurgence in inflation with market participants now requiring an “inflation premium” to go out 10 years on the yield curve. However, from that peak to now (December 6, 2023), we have seen the 10-year Treasury rate fall to 4.12%, thus implying a market view over that time horizon that the economy is NOT overheating, inflation is NOT accelerating, and the Fed is NOT likely to tighten again and, instead, is likely done with its tightening cycle and is preparing to loosen in the case where the economy begins to falter.
In perfect hindsight, from a total return perspective from July through December 6, 2023, one would have been indifferent to short versus long bonds since the total returns over this time horizon have been almost completely neutral (see chart below)! In the fixed income world we just saw a classic “round trip” where a strategy of short or long bonds would have been a satisfactory investment strategy over that time horizon! Short-term investment grade bonds (SLQD, the green line) marched slowly and sporadically higher in a narrow range, while riskier long-term bonds (LQD, the blue line) went on a wild ride ending up in the same place!
The lesson, of course, is to not try to time the market. Maybe you could get lucky and time the bottom and top, but it is unlikely. For long term investors, it is best to always stay diversified and plan for the long term!