According to a recent Bloomberg article, losses on longer-dated Treasuries are beginning to rival some of the most notorious market meltdowns in US history. In fact, bonds with a 30-year maturity are down 53% since March 2020 despite normally being associated with capital preservation! Since bond prices move inversely with interest rates, and since longer maturity bonds are more sensitive to rates, the impact on longer-term bonds has been particularly painful for investors of all stripes.
Because of higher interest rates, tighter lending standards, and higher operating costs, corporate bankruptcy filings have increased dramatically this year, and that trend will likely continue given the outlook for macroeconomic fundamentals. According to the American Bankruptcy Institute, 1,500 small businesses have already filed for bankruptcy this year while numerous notable larger companies, like Rite Aid
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And, while the US Federal Reserve has ratcheted up its overnight policy rate, the Federal Funds rate, to a range of 5.25-5.50%, it is simultaneously struggling to continue downsizing its COVID-era bloated balance sheet. Pursuant to its “quantitative tightening” program which started in 2022, the Fed is currently allowing $60 BN in Treasuries and $35 BN in MBS and ABS to mature each month without buying new ones to replace them. That massive monthly reduction in demand for new bonds has put additional downward pressure on market prices for bonds and helped to finally increase interest rates along the entire yield curve.
Because of this, and because US Treasuries serve as the benchmark security for pricing most loans, the cost of nearly all borrowing has spiked this year with notable jumps in consumer mortgage rates and automobile loans. In turn, new mortgage applications have dropped off and consumers have become more risk averse as compared with just a few quarters ago. Even more worrisome, many regional banks are struggling with massive unrealized losses on their balance sheets since they too bought billions of dollars in long-dated Treasuries when interest rates were nearly zero. Combine that with a worsening economic outlook, including rising defaults and troubles in office lending, and we are facing a perfect storm which already capsized some regional lenders earlier this year.
For investors looking to make sense of all this and to generate inflation-beating returns, the best advice we have is to be very selective and careful in deploying capital among investments that make sense despite the macroeconomic headwinds. On the long side, certain sectors, like commodity producers, defense companies, and certain event-driven situations like M&A, make a lot of sense. Similarly, the opportunity to buy distressed debt is becoming more attractive each day. On the short side, overleveraged companies with inflationary input costs are positioned particularly poorly right now. Lastly, well thought out and seasoned risk guidelines are important for success with any investment portfolio in this environment.
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