What’s up with the bond market in 2022?


We’re not halfway through 2022 and the bond market has sustained historic losses. Year-to-date, your bond investments are down somewhere between 10 and 20%, depending on whether you own intermediate or long term bonds. These losses are greater than any single year for the bond market dating back 100 years.

What’s going on?

A simple model for how bond values fluctuate is the following:

  1. Bond prices go down when interest rates go up. Longer term bonds go down more than shorter term ones.
  2. Interest rates are affected by many factors but inflation is a key driver. As inflation and expectations of future inflation increase, interest rates increase.
  3. Inflation has picked up considerably, you may have noticed.

Inflation goes up –> interest rates go up –> bond prices go down.

Will it continue?

Higher inflation is causing the bond market rout and there’s much debate in the econosphere about whether the inflation we’re experiencing is transitory or becoming anchored into our collective psyche (as happened in the 1970s and early 1980s) and thus more likely to be sustained for some period of time.

You may have seen some of the post-hoc analysis of how we got to this point:

  • too much pandemic stimulus money created excess demand for everything
  • a consumer shift from services to goods during the pandemic created excess demand for certain things
  • supply chain disruptions — e.g., container ship shortages, port backlogs, worker shortages, and Chinese production shutdowns — created supply shortages
  • Ukraine war dramatically raised energy prices

The Fed is on the case and they’re doing what they do — raising short-term interest rates and signaling they’ll continue — to cool off the economy and restrain inflation.

If you want to know if higher interest rates and bond market losses will continue — you need to have a point of view on what’s causing the inflation and whether the Fed’s efforts will be sufficient. As usual, I don’t have a crystal ball for what the future may hold.

What can you do?

I previously wrote about some steps you can do in our new inflationary environment and you can read those here. I’ll reiterate a few points:

  1. Track your monthly spending. Besides this being a variable over which you have some control, you can also calculate your own personal inflation rate over time. That will matter more to you than what the Bureau of Labor Statistics publishes every month.
  2. If you’re applying for a mortgage, carefully think through the decision of a fixed versus variable rate. It’s complicated and depends mostly on your future forecast for interest rates, but also how long you expect to remain in the home, how the rate is re-set, etc.
  3. If you own bonds or bond funds in a taxable account, make some lemonade from your lemons. That is, sell them and harvest the tax losses.  I wrote about that here. One reason that I advocate in favor of bond funds instead of individual bonds is that bond funds are much more liquid and thus easier to sell.
  4. Buy US Treasury Series I inflation bonds. They’re a bit of a hassle to purchase but they’re the best inflation hedge. I wrote about them here.

How important is the bond market to your everyday life?

Besides shrinking the value of your 401K, the “bond market” has a big effect on the overall economy as it’s where interest rates are determined for things like home mortgages and car loans. These rates obviously affect many of us, as well as the overall health of our economy, and they’ve jumped a lot in recent months. James Carville’s famous quip summed it up well:

I used to think that if there was reincarnation, I wanted to come back as the president or the pope or as a .400 baseball hitter. But now I would like to come back as the bond market. You can intimidate everybody.