2022 was the worst year in the history of the bond market, with the Bloomberg Aggregate Bond Index falling 13%, as the Fed raised policy rates seven times totaling 4.25%, which presented challenges even for the conservative eSAM Capital Foundation Account. The Fed started aggressively raising interest rates last March to fight high inflation and end its Covid-19 emergency Quantitative Easing policy. We were defensively positioned against rising interest rates in Capital Foundation, with 40% in Short-Term Bonds, which helped to a nice degree. It was a generational shift in fixed income overall, as interest rates rose sharply across the yield curve.
While the 2022 downturn was very rough for bond investors, it did create attractive forward return expectations for bonds with a foundation of higher yields, that were dismal ending 2021. In December 2022, we began a monthly process of moving towards a Neutral Bond Allocation in Capital Foundation for a normalized interest rate environment. We call this process a Duration Twist, gradually reducing our Short-Term allocation in 5% monthly increments and adding it to our Intermediate-Term allocation in Vanguard Intermediate-Term Bond ETF. We completed Phase 1 of the Duration Twist process in April, bringing our Short-Term Bond allocation to 15% and raising Intermediate-Term Bond to 85%. While the yield curve is still inverted, with short-term rates higher than longer-term and a leading indicator of a recession, we anticipate a return to a normal, positively sloped yield curve over time (short-term rates lower than longer-term) and we are prepping Capital Foundation.
The Fed has been aggressively raising interest rates to combat high inflation, including two 0.25% hikes in Q1 and nine times overall since last March totaling 4.75% (ending April). We are close to the end of that process, as inflation has been steadily trending down since last June, though at 5.0% (March) it has remained stubbornly above the Fed's 2% target ending.
[Update]: We expected another 0.25% at the early May Fed meeting, and that is what the Fed delivered with its 10th straight rate hike totaling 5.00%. While a pause is now expected, as recession risks have risen, the market is pricing in one or more interest rate cuts by year-end; however, the Fed is not projecting a rate cut until 2024.
We continue to concentrate eSAM Capital Foundation on Core Allocations to further support our ultra low-expense mandate to keep eSAM weighted expenses at or under 0.10%.
Volatility remains in the forecast for interest rates and bonds, as recession risks remain elevated. We will continue to prudently manage those risks with a long-term focus on capital preservation and total return for our eSAM Capital Foundation Account.
