(Bloomberg) — Bond investors face a crucial decision about how much risk to take on Treasuries as 10-year yields are at their highest in more than a decade and the Federal Reserve signals it is almost done raising interest rates is.
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As individuals accumulate money, the question for many portfolio managers is how far to go in the other direction. Two-year yields above 5% haven’t been this high since 2006, while 10-year yields topped 4.5% on Friday for the first time since 2007.
For Columbia Threadneedle’s Ed Al-Hussainy, the sweet spot now is in the shorter maturities, which would likely perform well if the Fed moves to cut rates in a few years. This maturity also avoids the added risk of longer maturities, which have weighed on bond investors the most in 2023 as yields have generally risen amid a robust economy and rising Treasury issuance.
“If you don’t think the Fed is going to be on hold for two years,” said Al-Hussainy, a global interest rate strategist, said Al-Hussainy, a global interest rate strategist. “The longer end is where you get hurt the most.”
To push this further, he said, “there needs to be a stronger belief that the labor market will collapse.” This scenario could lead investors to bet on a recession, triggering a rally in Treasury bonds and leading to outsized gains on longer maturities, which is due to their greater sensitivity to interest rate changes.
With the labor market proving robust, this is unlikely this year, Al-Hussainy said.
“You can be very patient before doing your best to get duration in the Treasury market,” he said.
Tough week
The story goes on
Yields rose across the curve this week after the Fed left interest rates unchanged while announcing another rate hike this year and suggesting it expects to keep borrowing costs high well into 2024 to curb inflation . This outlook means that even short maturities may not be out of the woods.
What Bloomberg strategists say…
“The resounding sell-off in short-term Treasury bonds that we have seen this cycle is not over yet, and yields are likely to reach their highest levels in more than two decades if the Federal Reserve follows the path of its recent dot plot.”
– Ven Ram, Markets Live Strategist
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Treasury bonds have fallen 1.2% this year through Thursday, on track for an unprecedented third straight annual loss, Bloomberg index data shows. Medium-term debt remained roughly unchanged over the year, while longer-term debt lost 6.6%.
ING Financial Markets LLC said this week that it sees risk of another selloff that would push 10-year yields to 5%.
At the moment, the front end seems to have the most appeal. U.S. Treasury mutual funds and ETFs with maturities of four years or less have seen inflows of about $10.3 billion since the end of July, according to EPFR Global data through Sept. 20. Intermediate-term maturities attracted $3.25 billion, and funds with maturities longer than six years attracted $5.5 billion.
The Fall of the Bulls
For some bond bulls, longer maturities are still the right choice, despite the risk of additional losses. This camp has argued all year that rising borrowing costs will inevitably hurt growth.
Jack McIntyre of Brandywine Global Investment Management said he expects the 4.5 percent range to remain in place for the next 10 years given recent weakness in stocks and rising oil prices.
“Significantly lower equity valuations would contribute significantly to tightening financial conditions for asset owners, while higher energy prices tighten financial conditions for low earners,” the senior portfolio manager said.
He is overweight duration in emerging markets and government bonds and is watching for signs that economic activity and inflation pressures will continue to cool.
It can all be a question of time horizon. For those with longer investment mandates, longer-dated Treasury bonds are at a level that means “your baseline for future returns is quite attractive,” said Michael Cudzil, portfolio manager at Pacific Investment Management Co.
US budget deficits and the Fed’s attempt to shrink its balance sheet complicate this long-term view. This is a backdrop that has led investors to demand a higher risk premium for longer-dated bonds, helping the curve steepen from historically inverted levels.
“We are in an environment where it is difficult to imagine that we will return to the levels of long-term interest rates of the last decade,” said Jay Barry, head of U.S. Treasury strategy at JPMorgan Chase & Co.
The result, he said, is “a steeper yield curve with long-term interest rates that simply remain elevated even as the market finally adjusts to the Fed’s holding pattern.”
What you should see
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Economic data:
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September 25: Chicago Fed National Activity Index; Dallas Fed manufacturing activity
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September 26: Philadelphia Fed non-manufacturing activities; Bloomberg Sept. US Economic Survey; FHFA Home Price Index; S&P Corelogic US Housing Price Index; sales of new homes; Conference Board Consumer Confidence; Richmond Fed Manufacturing Index/Business Conditions; Dallas Fed service activities
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September 27: MBA Mortgage Applications; Orders of durable goods/capital goods
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Sept. 28: GDP; initial claims for unemployment benefits; Kansas City Fed manufacturing activity; upcoming home sales
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Sept. 29: Advance trade balance in goods; personal income/expenses; PCE deflator; MNI Chicago PMI; U. of Michigan Mood; Kansas City Fed service activities
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Fed calendar:
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September 25: Neel Kashkari, Minneapolis Fed President
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September 26: Fed Governor Michelle Bowman
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9/10/28: Chicago Fed President Austan Goolsbee; Fed Governor Lisa Cook; Chairman Jerome Powell Town Hall with Educators; Tom Barkin, President of the Richmond Fed
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September 29: New York Fed President John Williams
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Auction calendar:
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September 25th: Invoices for 13 and 26 weeks
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September 26: 42-day cash management invoices; 2-year bonds
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September 27: 17 week bills; 2-year floating rate bonds; 5-year bonds
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September 28: 4, 8 week bills; 7-year bonds
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