Thoughts in Charts: Difficult Bond Start – Will it Persist?

I’m extremely skeptical of statements that declare a hard line between two ideas. I’ve found that very little in life is ever as easy as 100%. This week’s chart stood out to me as an illustration of how most of our lives (both real and financial) require us to get comfortable in the grey.

One fact within the bond market is that bond prices decrease when interest rates increase. It’s a function of bond pricing. When applied in the real world, however, that statement is not as black and white.

This week’s chart shows that, as of February 28th, the bond market has had its 2nd worst start. Longer term loan rates have gone up in anticipation of the Federal Reserve raising short term rates. The marketplace is expecting interest rates increase several times this year and probably on into next year. If we are living in a black and white world, bond prices have nowhere to go but down.

The second chart on the right offers a little food for thought on that assumption. It notes that, following the 10 worst starts, bonds historically have had a positive return over the next 10 months.  In seven of the cases, the upside has been enough to end the calendar year in positive territory.

The chart doesn’t dive into interest rate activity on each of these years; however, I want to note something interesting. The worst start list doesn’t include 2017. I mention this because the Federal Reserve raised rates in March, June, and December of 2017. The “rule” would assume that the Bloomberg US Aggregate Index, which is generally considered a measure of the US fixed rate investment grade bond market, should have lost value that year. Instead, the index returned over 3% in 2017.

The Fed kept raising into 2018, which did make the list as one of the 10 worst starts to a year. They raised rates 1x per quarter that year. As you notice in the chart, the Bloomberg US Aggregate Index ended flat on the year.

So let’s take a step back and look at the entire rate rise period between 2015-2018. Rates increased in December of 2015, December of 2016, and then throughout 2017 and 2018, moving the short-term target rate from a 0-0.25% range to 2.25-2.50%%. From the first raise through the end of 2018, the Bloomberg US Aggregate Index returned an annualized 1.98%.1 The following were the calendar returns on the Bloomberg US Aggregate Index over that period:

Past performance doesn’t mean that it will behave this way going forward. What it does tell us that there have been periods where the Fed has hiked 9x and returns remained positive. Nothing is ever as simple as 100%.

1 Data sourced from Morningstar Direct referencing the annualized performance of the Bloomberg US Agg Bond TR USD Index from 12/16/2015 to 12/19/2018. You cannot directly invest in an index.