2022 can best be described as the year when the negative interest rate environment ended. Following the spike in inflation all the major central banks tightened monetary policy aggressively during the year. In essence, the era of ultra-loose monetary policy measures came to an end and yields jumped up accordingly, reflecting the new inflationary environment being witnessed.
In the US, the Federal Reserve conducted its sharpest increase in interest rates ever as inflation jumped to the highest levels in 40 years. The Fed announced seven consecutive rate hikes in 2022, thereby raising the target federal funds rate range from 0% to 0.25% at the start of the year to 4.25% to 4.50% − the highest level since December 2007.
The European Central Bank (ECB) hiked interest rates four times during 2022, raising the deposit facility to 2%. The increase in July 2022 marked the ECB’s first interest rate hike since 2011. Previously, the ECB’s deposit facility rate had been stuck at -0.5% since 2019 and below zero since 2013.
As a result of the sharp upward moves in interest rates, bond yields rallied to their highest levels in many years.
In the US, the 10-year Treasury yield surpassed a level of 4.2% last month before easing to a current level of 3.75%, marking a significant increase compared to its 1.5% level in December 2021.
Across the eurozone, the yield on the 10-year German bund jumped above 2.5% this year from -0.179% in December 2021. In Italy, the 10-year bond yield spiked to 4.9% compared to -1.40% this time last year.
In the past few months, there was increased volatility in yields as the markets reacted to the publication of economic and inflation data as well as to comments by top ECB officials. In fact, the yield on the 10-year German bund fell from 1.75% in June 2022 to 0.76% in August, before rallying to 2.4% in October. Yields then eased once again to 1.78% in early December before touching 2.50% earlier this week.
This intense volatility in sovereign bond yields is rather exceptional, and resulted in wild swings in bond prices in a relatively short period of time.
As explained in several of my articles in the past, there is a clear and natural correlation between movements in yields across the eurozone and those on Malta Government Stocks. The sharp upward movement in yields throughout 2022 and the high degree of volatility experienced over the past few months was also reflected in Malta as the yield on the 10-year MGS shot up to 3.8% compared to a level of 0.80% at the start of the year.
The RF MGS Index, which is based on the MGS prices published by the Central Bank of Malta on a daily basis, declined by an extraordinary 18.7% in 2022 – the worst annual performance on record – as yields spiked. This is also the third annual consecutive decline in the MGS index as yields moved higher following an unprecedented period of very low yields caused by the ECB’s quantitative easing programme.
The extent of the decline in bid prices in 2022 quoted by the Central Bank of Malta for several of the longer-term MGSs is rather astonishing as most securities decrease well below their par value. For example, the price of the 3% MGS 2040 fell by just over 38 percentage points from 126.61% in December 2021 to just above 88% a few days ago. Likewise, the 1.80% MGS 2051 – a 30-year bond launched in 2021 – saw its price plummet from 98.81% to 62.05%.
Similar to the exceptional sharp jump in MGS prices seen in 2014 and 2015 at the start of the ECB quantitative easing programme, the negative movement in prices in recent months is also severe by historic standards and not a normal feature associated with fixed-income instruments.
While 2022 was a brutal and painful year for investors holding MGS in their investment portfolios, the silver lining for the investing public holding excess idle liquidity is the higher yields available from the bond markets locally as well as internationally. This was very much in evidence when in October 2022, the Treasury issued a 10-year MGS at a yield of 4%, with the result that retail investors responded very enthusiastically and applied for just under €300 million.
The silver lining for the investing public holding excess idle liquidity is the higher yields available from the bond markets locally as well as internationally
While the higher yields will prove costly for borrowers, including the Maltese government, which needs to raise a record amount of €1.6 billion in new MGSs in 2023, the ample levels of liquidity in the financial system augur well for the government and other corporate bond issuers aiming to tap the market in 2023.
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