Higher Interest Rates Are Coming. Bonds in the Crosshairs.
When interest rates rise, bond prices go down. Most people move more of their portfolios into bonds as they age looking for a more conservative portfolio allocation. Many people will use their age as a guidepost to the percentage of bonds in their portfolio. For example, someone who is 65 will put 65% of their portfolio into bonds. Since this portfolio allocation strategy is prevalent, it means an uncomfortably large percentage of retirees have most of their portfolios exposed to an obvious, present, and predictable danger.
For the last forty years, rates were falling, so bonds were considered safe and predictable. However, bonds are one of the worst places to have money when rates rise. High inflation and rising interest rates have made holding bonds extremely risky. When inflation begins consistently falling, that will be an excellent time to get back into bonds until the next inflation crisis. However, now is the time to get out of harm's way.
At the annual Jackson Hole Conference, Federal Reserve Chairman Jerome Powell committed to raising interest rates to around 4%. Powell stated rates will be at least at that number until the end of 2023. The current Federal Funds interest rate is between 2.25-2.5%. In 2022, rates have risen 1.5% and bond prices have already lost more than 10% this year. St. Louis Fed President, James Bullard, thinks there will be another 1.5% interest rate points added to the interest rate before the end of the year. If the bond market reaction continues, bonds could see another 10.4% loss before January 1, 2023.
The average retirement is between 19-21.5 years. Suppose people don’t want to leave any money to children and spend their last penny on the day they die. People could spend about 5% of their savings every year. A 20% bond loss would equal about four years of retirement funding. It is much harder to make money back than to lose it. If an asset costs $100 and losses 20%, the new value is $80. For an asset costing $80 to climb back to $100, it needs to grow by 25% ($80 + $20= $100. $20 is 20% of $100, but $20 is 25% of $80). In normal markets, the average bond yields about 5-6%. To earn back to where bonds were before the rate hikes, one will need to wait for inflation to return to normal numbers and then an additional four to six years. When inflation data settles, it will probably cost more than four years of funds. Retirees don’t want to wait another six years for their portfolios to recover.
|Tightening Cycle||Fed Funds Rate Peak||CPI||Effective Rate|
Source: Minneapolis Fed
Chairman Powell committed to nearly 4% interest rates until the end of 2023, five quarters from now. However, Chairman Powell also stated that he would not make the mistakes of history not being aggressive enough to reduce inflation. History has shown that the interest rate needs to be a few percentage points above the CPI to lower inflation. The graphic is a month outdated. The current CPI is 8.5%. The interest rates will likely have to go much higher than 4%. If high inflation persists, rates may need to be close to 11-12%, like in 1973. If rates go even half that high, millions will suffer incredible losses in their bond portfolios and lose years of savings.
High inflation will likely persist, and interest rates will continue rising for at least another year, maybe a handful. There is a lag time between printing and the inflation effects felt across society. Usually, it takes about 12-18 months for printing to reach the inflation numbers. Since March 2020, 80% of all dollars in circulation have been printed. In March 2020, there were 4,261.9 billion dollars in circulation. As of July 2022, there are 20,514.7 billion dollars in circulation. The aggregate inflation since March 2020 is about 15%, but money in circulation (M1) has increased by 480%! The current inflation numbers only represent about 3.25% of all the new dollars printed. This train isn't slowing down any time soon. Chairman Powell said the Fed is committed to doing whatever it takes to secure price stability, which means interest rates are going as high as needed.
The inflation issue is more than waiting for printing shoes to drop. Since the Dollar is the primary reserve currency, the U.S. can export inflation to other countries. However, suppose all those Dollars come back stateside. In that case, we might ask Zimbabwe and Venezuela for tips on handling hyperinflation. There are many reasons to believe the world is deliberately de-dollarizing. The world watched the sanctions placed upon Russia very closely and has been systemically de-dollarizing their economies to protect themselves. The BRICS (Brazil, Russia, India, China, and South Africa) have established trade agreements outside of the Dollar. Also, they have been working on a basket of currencies for countries to transact internationally outside the Dollar. China and Saudi Arabia continue negotiating for Chinese oil in Yuan. In a recent survey, 42% of central bankers stated they intend to hold fewer Dollars five years from now. These are just a few of countries' deliberate actions to de-dollarize. Those Dollars will have to go somewhere, and the most likely place is back to the U.S. economy. It is not a matter of “if” the world starts sending some of those Dollars back, but when, how many and how fast it happens. When the Dollars arrive in large numbers, expect unthinkable interest rates and even more disaster for bonds.
What Can You Do About It?
When interest rates were dropping, bonds made perfect sense. For forty years, market conditions all but guaranteed a bond portfolio was a sure thing. However, the rules have changed, and bonds are now very dangerous. It doesn’t make sense to drive on the interstate in reverse and use your rear-view mirror to steer. Unfortunately, many people have this rear-view mirror attitude as they watch their retirements get destroyed in the bond market. Bonds are a pleasant memory in the rear-view mirror. However, the rear view also shows a giant printing fireball headed straight at the bond market to destroy that memory.
Historically, gold and other precious metals have been the asset of choice in tough economic times. Gold does wealth protection best, which is the logic of why people turn to bonds in later years. However, bonds are failing and will continue to fail. Bonds were considered conservative and recommended because they hold principal well. Gold has a 5,000-year track record of doing what bonds are failing to do now, protect purchasing power. Even if gold were not to grow one penny, 0% is a lot better than -10%. However, there is an excellent setup for gold right now. Now is a great time to get into gold. The current price is low historically. The upside is tremendous, and bonds are about to get wiped out again. What is there to think about? Do it today.
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