Looking to the Futures: Bonds Bounce After Bad Year

Bonds are bouncing into the new year after notching a record annual loss last year. The 10-year treasury yield dropped by 15.5 basis points on Tuesday, marking the second-best drop on the first day of trading since 2001. The yield curve inverted last year at several points, a harbinger of economic contraction, peaking in October and November as the Federal Reserve began its fight against the highest inflation in 40 years. The Consumer Price Index (CPI) peaked in June at 9.1% y/y and dropped to 7.1% y/y in November, while core CPI peaked at 6.6% in September and came back in to 6% in November.

The 5-year yield exceeded the 30-year yield by 46.8 basis points at one point, while the 2-year hit a premium of 85.2 basis points over the 10-year yield on December 7th. The 5-year inflation expectations implied by yields on Treasury inflation-protected securities (TIPS) culminated in March at 3.7% and have come back down to 2.38%.

Last January, swap contracts on Fed meeting dates priced in only four quarter point rate hikes for the year. The Federal Reserve followed expectations in March raising rates by a quarter point. In April, the market started pricing in 50-point hikes for the next four meetings. In June, the Fed increased their tempo to 75-point rate hikes, the first since 1994. In December the Fed officials dot plot showed a median fed funds rate of 5.125% in 2023.

The Bloomberg US Treasury Index dropped 12.5% last year in its second straight calendar-year loss and largest in its history. The worst performing months were September, March, and April; all dropped over 3%. The first quarter of 2022 started with a 5.58% drop which would be the worst quarter of the year.

By the end of the year yields had shot up precipitously with the 2-year(+369bp), 5-year(+274bp), 10-year(+236bp), and 30-year(+206bp).