Stocks and bonds fell in February after recovering over the past four months from the declines of early 2022.
Bonds prices fell as the benchmark 10-year Treasury rate rose to 3.92% at the end of February from 3.52% at the end of January. This rate began 2023 at 3.88%, after starting 2022 at 1.51%. We discuss interest rates in more detail below.
Stock indexes dropped between 2% and 6% for the month, but all except the Dow Jones Industrials remained positive for 2023. The Nasdaq index, which includes most of the large tech companies, were up almost 10% for the year through February after tumbling more than the broader markets in 2022.
Interest Rates Remain Key
The US Federal Reserve and other central banks continue their efforts to raise rates enough to fight inflation without triggering a major recession. Through January 2023, the Consumer Price Index declined from over 9% in mid-2022 to less than 6.5%. More recent data have shown a slowing of the rate of decrease, however, along with better numbers on employment. This reduces fears of recession, but also raises the possibility that the Fed will continue, and possibly even quicken, its pace of interest rate increases. In testimony to Congress on March 7, Fed Chair Jerome Powell said that “the latest economic data have come in stronger than expected, which suggests that the ultimate level of interest rates is likely to be higher than previously anticipated.”
Rates Rise Together
It’s important to note that when the Fed raises short-term rates, and longer-term rates determined by the broader bond market increase, it affects what you pay but also what you earn. As most of you probably know, 30-year fixed rate mortgages have risen to 7% and the prime rate, which determines the pricing on many adjustable rate loans, is up to 7.75%. For clients with “Pledged Asset Lines,” lines of credit secured by the value of your brokerage account, you’ve become aware that SOFR, the Secured Overnight Financing Rate, has increased to about 4.7%.
What you might not be as aware of is that the rates you’re being paid have adjusted upwards as well. Short-term Treasury bonds now pay 5% or more, and short-term bond funds yield almost 4.75%. High-yield bonds and bond funds are earning between 6-7%. Even very short-term investments such as purchased money market funds are paying 4.5-4.75%.
So the earning rates remain below the paying rates, but they are at least in the same ballpark.
What It Means for You
This is still a period of significant uncertainty. Depending on employment and other economic data, the Fed might keep raising interest rates for some time, perhaps another year. If that happens, there may be a recession and stock and bond prices will likely decline, although you will be earning more income from interest and dividend payments (remember, interest rates and bond prices move in opposite directions). At some point, though, inflation indicators will decline further, which should lead to recoveries in the stock and bond markets.
So as we suggested last month, we don’t recommend making any short-term portfolio adjustments for clients with long-term investment horizons. For clients with shorter investment timeframes, the wisdom of potential changes depends on your current exposure to the various parts of the stock and bond markets. In either case, we encourage you to check in with your PPA advisor if you’d like to discuss the implications for your specific situation.
Read “Markets Stumble in February” in the Piedmont Exedra.