In early February 2018 equity markets started to sell off. Volatility increased. On February 8th, 2018 the DJIA dropped over 1000 points.
Answer: The repricing of risk.
In 2013 the economy was recovering from the Great Recession of 2008/2009 and was still fragile. A lot of economic data points showed contradictory trends. Believing the economy had sufficiently strengthened, the Federal Reserve announced it’s intention to start reducing its policy of Quantitative Easing which was put into place after the 2008 financial crisis and the Great Recession. Quantitative Easing was the government policy to buy US treasury bonds in order to keep interest rates low and support the economy.
As a result of this policy bonds have had very low yields for several years.
This announcement resulted in a stock market reaction known as the “Taper Tantrum”. Equity markets declined over fear that the Fed would raise interest rates too aggressively and push the US economy back into recession.
As a result of the “Taper Tantrum” the Fed slowed its approach to reducing QE taking a measured approach that lasted 4 years before the Fed stopped purchasing assets and started to increase interest rates.
The recent sell off in the markets occurred as the 10 year yield rose above 2.7%. As interest rates move higher, bond prices and bond values move lower.
What caused this shift? The Republican Tax Cut bill was finalized on December 19th, 2017. The tax cuts were largely unfunded and as a result economists expect larger deficits to finance the government going forward. This means more bonds being issued, more supply of bonds in environment where the the government has stopped buying bonds to support the price… As a result bond prices have declined and bond yield have risen.
From Dec 18th, 2017 to Feb 8th, 2018 the following has occurred:
The 20 year bond yield has increased 18% from 2.55% to 3.03%.
The price of the 20 year treasury has fallen 7%.
The US dollar has fallen 6%.
Economists have called this the “repricing of risk”. As rates move higher it is possible that investors will sell bonds which are declining in price and instead buy other assets.
Ira Jersey, Economist at Bloomberg news stated “it is rising rates and uncertainty driving the markets”. He continues by saying “the economy is strong and what’s happened in the past when there have been similar selloffs, the equity market finds a floor.”
What does this mean for retirees? It is important to incorporate strategies that manage risk in your investment portfolios. Bill Gross, famed bond manager, has called this “the New Normal”. A period where markets exhibit volatility and limited gains.
If you are concerned by the current environment, please feel free to reach out to me. Learn how you can reduce risk going forward in an increasingly volatile environment.
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