While 2021 was all about the equity market, 2022 so far has been all about the fixed-income market. U.S. Treasuries have seen one of the largest sell-offs in a generation, driven largely by investors’ fears over rising inflation. U.S. CPI printed at 8.5% for the month of March, one of the highest readings since the 1970s. Gains across categories were broad-based, with food, energy, and services all climbing, partially offset by a decline in used car prices.
The Federal Reserve has pledged to do its part to help get inflation under control, but so far has been very slow to act. The policy rate (fed funds rate), currently stands at only 25 basis points, while inflation is at 8.5%. That said, as we have noted in prior pieces, we aren’t sure that Fed policy will be able to cure all the reasons for high inflation. It may help with a few of them, but raising interest rates is unlikely to fix the issues in supply chains, such as the backlogs at Chinese ports, as shown in the figure below.
So far, inflation has shown little signs of slowing, so we continue to favor short-duration fixed income strategies, which has helped to minimize exposure to the sell-off in bond markets. That said, every challenge is also an opportunity, and the rise in inflation has greatly benefited commodities, which we have been strong proponents of using within portfolios over the past 1-2 years. While energy has led the gains over that time period, agriculture and metals have also benefited.
Stepping back six months ago, our view was that inflation was likely to trend higher, geopolitics was likely to move from the back burner to the front, and value stocks, along with energy and commodities, were going to play an important role in portfolio diversification. Much of that has since come to pass, and while it’s hard to say how the geopolitical environment will evolve, we remain constructive on value stocks and commodities going forward.