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"Worst Drawdown on Record" for Global Bonds: Why the Fed Can't Help

by Murray Gunn
Updated: March 30, 2022

This article has been featured on numerous financial media sites including Yahoo! Finance, MarketWatch, Seeking Alpha, Morningstar and Benzinga.

Bloomberg recently reported that global bond markets have suffered unprecedented losses since their peak last year, wiping out $2.6 trillion in market value. Macroeconomics 101 teaches that the Federal Reserve (and central banks in general) control interest rates in the economy, so is the Fed coming to the rescue?

Don't bet on it. The Fed is simply at the mercy of the market. The Fed's federal funds rate tends to follow trends in the freely traded bond market.

The market sets interest rates, and the Fed follows. They are reactive, not proactive.

The Fed's most recent move -- a quarter-point increase in its federal funds rate target -- adheres to this script. Rates began moving higher in parts of the bond market in 2020. By the beginning of this year, rates even on the short end of the yield curve had joined the trend. The Fed's decision to increase the federal funds rate earlier this month, therefore, merely followed the rises in market rates.

But there is one thing that Macroeconomics 101 gets right about bonds: rising interest rates mean falling bond prices. Thus, the giant drawdown that traders have faced recently.

Instead of looking for a central bank savior, traders and borrowers alike would be better served preparing for the ramifications of rising rates. Consider the 2-year note. On February 5, 2021, it yielded 0.105%. Today the rate is near 2.3%. That's a nearly 22-fold increase in just over a year.

In dollars-and-cents terms, $1 billion borrowed at 0.105% would cost about $1 million in annual interest. But at today's rates, the same loan costs nearly $23 million per year.

Imagine if a company were facing such a huge increase. The additional money required to service the loan must come from somewhere. We're talking the potential for smaller bonuses, lower salaries, fewer perks. And in some cases, all of those still won't address the issue.

For our part, we warned subscribers in August 2020, "rising interest rates will suck money out of every investment account, bank account and mattress, and the race for cash will be on." The October 2020 issue of The Elliott Wave Theorist showed this 78-year history of interest rates as measured by the yield on the 10-year Treasury note.

78-year interest rate cycle

We told subscribers at the time, "Interest rates likely bottomed in March [2020], which means bond prices have begun a significant fall."

Interest rates are going up no matter what. The Federal Reserve is just along for the ride like everyone else. There's no cavalry coming.

Looking for more interest rates forecasts? We have two services that can help: Our Financial Forecast Service provides important investor-focused insights and coverage while our Interest Rates Pro Service gives you intensive, trader-focused coverage.

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