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Bonds markets will not suffer Fed ‘shock’ approach collapse

11 March 2018

Bond markets will not experience a 1994 style crash, despite concerns about the speed of US rate rises, says Kames Capital. 

US short-term rates have risen five times since December 2015, and during its January meeting, the Fed signaled further rate increases for 2018.  The Fed is expected to increase rates three times over the course of the year, but there are concerns that hikes may move even faster, sparking fear of a repeat of 1994 when bond values plummeted.

Adrian Hull, co-head of fixed income at Kames Capital, said: “The bond market’s memory is arguably short. But 1994 remains vivid as the last time interest rates were raised in an aggressive, systemic fashion led by the US Federal Reserve. In just four months from 4 February 1994 the Fed raised rates by 200bps, shocking bond investors and sparking a sell-off.

“The effect was dramatic, with a near doubling of 2-year Treasury yields to over 7.5%, as Fed Funds moved to 6% from 3% during the year. Market participants rightly fear a return of such bear sentiment but a re-run is not on the cards.”

Hull said the 90s sell-off was caused by the Fed’s “shock” approach to raising rates. In comparison, today’s policymakers regularly signal their stance, with further rate hikes already reflected in market prices. While bond investors can expect some volatility and a longer period of lower returns, they will not experience a collapse in prices.

Hull also notes the deflationary effect companies such as Amazon have on the US economy, limiting the scale of the inflation uptick. Quantitative easing has also contributed to lower rates, but the unwind of QE will be a lot slower than the purchasing of those bonds.