While the lion’s share of market attention is usually given to equity markets, the past couple of months have seen fixed income increasingly come into focus, as a sell-off in longer-dated bonds gathered steam. From their peak of last year, longer-dated bonds declined by over 20% through last March 18th, and although yields have stabilized a bit over the past couple weeks, upcoming inflation data like CPI will be closely watched by investors to see if inflation continues to pick up steam. We believe a combination of supply chain shortages, increased spending by consumers, higher oil prices, and continued fiscal stimulus is causing some prices to increase rapidly, and this is causing investors to reduce risk in fixed income portfolios by selling bonds with longer-dated maturities due to concerns over rising inflation in the future.
As a firm, we have generally recommended over the past year that fixed-income portfolios should have an overall duration of intermediate-term duration or less, due to the fact that when yields are so low on a historical basis (as they were last year), even a modest increase in yields in longer-duration bonds can cause significant drawdowns in price.
Looking ahead, we believe the path of yields will be heavily dependent on both economic data and policy. If inflation data continue to come in above expectations, the bond sell-off could have another leg to go. Policy will also be in focus, not only with respect to the Federal Reserve but also with housing policy as well. Recall that currently there is an eviction and foreclosure moratorium across the United States, which is artificially curtailing the supply of properties on the market, which is causing a rapid increase in prices across the country. If policymakers decide in June to let these policies expire, as some housing experts think, this may serve to keep inflationary forces in check by taking some of the froth out of the housing market, which caused lumber prices to increase by as much as 250% over the past year.