Last month, we wrote about our hope that investors had finally shifted their focus away from the Federal Reserve and back to fundamentals. Alas, February revealed that hope to be premature, but for reasons that may sound counterintuitive. A very hot jobs report came out on February 3rd. The data showed the U.S. economy added a whopping 517,000 jobs in January, more than double the previous month. The same report showed the unemployment rate also hit a 40-year low at 3.4%. A widely followed survey of businesses showed the service sector moved from contraction back into expansion. Home sales picked up. Apparently, this was too much good news.
In a return to a now-familiar “good news is bad news” dynamic, these reports stirred fears that the economy is still running too hot and that the Federal Reserve will have to continue raising rates. The stock and bond market rally that began in January halted immediately. The newest inflation report released in the middle of February also didn’t help. It showed that year-over-year inflation only came down 0.1%. The net result for the month was a 0.40% increase in the yield on the 10-year bond, and a decline of about 2.5% for both the U.S. stock and bond markets.
To start 2023, investors were hopeful that high inflation would quietly recede from the headlines. So far, there hasn’t been much of that. Accordingly, the Federal Reserve is likely to continue increasing rates beyond May. Although rate increases are anticipated, it is unlikely that the increases would climb to the levels of 2022. And while last year’s rate increase campaign put pressure on bond prices, investors would be wise to not turn their back on the asset class. Tighter monetary policy may have depressed bond prices, but it also created the most attractive fixed-income market in over 15 years. U.S. Treasuries currently pay between four to five percent interest. The last time an investor could receive such high levels of yield from Treasury bonds dates back to the aughts. The Federal Reserve has opened a path to better returns from bonds.