The Lost Decade
Bryan Taylor, Chief Economist, Global Financial Data
2022 was one of the worst years for fixed-income investors in history. Bonds lost money. Stocks lost money. Crypto lost money. Inflation rose to levels not seen since the 1980s. The only thing that increased in value were commodities. You have to go back to the Civil War in the United States or the Napoleonic Wars in Britain to find a worse year for bonds.
Nowhere to Hide
When Covid hit the world in March 2020 and businesses shut down, governments did everything they could to keep the economy from collapsing. The Federal Reserve and other central banks lowered interest rates to negative real levels to spur growth. The United States ran a government deficit equal to 10% of GDP to keep the economy afloat. After a sudden collapse in the stock market, equities made a dramatic reversal, hitting bottom in March 2020 and moving upward through the end of 2021.
After Covid began to subside, problems began to appear. Many people had been laid off during Covid, and some of them chose not to return to work. The labor supply tightened and, combined with the push for higher minimum wages, the cost of labor began to rise. When prices started to increase in 2021, the Federal Reserve warned that the inflation would be temporary and that investors should not worry about it, but inflation continued to rise and did not go away. It peaked at 9.1% in the United States in June 2022.
In February 2022, Russia invaded Ukraine. This pushed up commodity prices, feeding the inflation that had already built up in the economy. By the time the Fed was willing to admit that inflation was approaching levels the developed world hadn’t seen in 40 years, it was too late. The Federal Reserve and other central banks had to act quickly to stop inflation from becoming endemic in the economy.
The Fed Raises Interest Rates
The Federal Reserve raised the Federal Funds Rate from 0.00%-0.25% at the end of 2021 to 4.25%-4.50% by the end of 2022 with future rate increases promised in 2023. The yield on the 10-year Government Bond in the United States rose from 1.52% at the end of 2021 to 3.88% by the end of 2022. The European Central Bank Deposit Rate rose from 0.5% to 2% in 2022. The yield on the German 10-year Bund rose from -0.21% at the end of 2021 to 2.51% by the end of 2022. Interest rates rose rapidly throughout the developed world from their lowest levels in history at unprecedented speed.
Figure 1. United States 10-year Bond Yield, 1792 to 2022
Consequently, bond prices collapsed, and bond yields rose. GFD’s Index of returns on US 10-year bonds showed a decline of 17% in the year to December 2022. This was the second year in a row that US fixed-income investors lost money. GFD’s Index of 10-year government bonds lost 3.93% in 2021.
To add insult to injury, inflation reduced real returns even more. Consumer prices rose 7% in 2021 and 6.5% in 2022. This means that after inflation, investors lost 11.2% in 2021 and 24.6% in 2022. This comes to a cumulative 38.6% loss in two years. As can be seen in Figure 2, the real yield to bond investors has been falling since 1981 and in 2022 fell to the lowest level since the 1940s. Despite an increase in the government bond yield, the real yield remains negative. To call these investments risk-free is truly an oxymoron.
Figure 2. United States Bond Yield After Inflation, 1792 to 2023
It is rare for GFD’s US Government Bond Index to decline two years in a row, and during the past 230 years, the index has never declined for three years in a row. In the past, most successive year declines were small, at only 2-3% each year. Only in 1860 and 1861 were there successive declines of 6.5% each year. The decline in 2021 and 2022 was unprecedented. Declines this large in successive years had never occurred in US history.
Given the Federal Reserve’s determination to keep interest rates low to help the economy, it seems inevitable that yields in 2022 will continue to increase. As Figure 2 shows, real bond yields have been declining steadily since 1981 and went negative during the past couple years. As Figure 3 shows, the Federal Reserve has kept the real Fed Funds Target Rate negative during most of the twenty-first century, reaching a negative 8% in 2022. Only toward the end of 2022 has the combination of lower inflation and higher interest rates, pushed the real Fed Funds Official Target Rate to a negative 2%. One wonders how much longer negative real interest rates will persist. The Fed policies are not friendly to those who save.