NEW YORK, Dec 30 (Reuters) – US Treasury investors, suffering after the largest annual decline in the history of the asset class, weather another sell-off as concerns over persistent inflation cloud prospects for an expected recovery in 2023.
Heavyweights like Amundi, Vanguard and BlackRock turned bullish on bonds in recent weeks on expectations that inflation has peaked and that a potential recession next year could prompt the Federal Reserve to end its most aggressive cycle of interest rate hikes in decades break up. Many investors have followed this example. BofA Global Research’s December survey found that fund managers were the most overweight bonds versus stocks in nearly 14 years.
But while bonds rallied in October and November, prices have fallen in recent weeks as investors digested stronger-than-expected US economic data and as China reopened COVID-19 restrictions, some believe Price pressures could intensify in the new year.
Falling prices have boosted yields, which move inversely. Benchmark 10-year government bond yields have risen more than 40 basis points to nearly 3.9% since mid-December, the highest in over a month. Two-year yields — which tend to reflect policy expectations — hit 4.445% on Tuesday, their highest daily high since November.
“The market appeared to be overwhelmed and awaiting a turnaround from the Fed,” said Michael Reynolds, vice president of investment strategy at Glenmede. “He’s coming to terms with the fact that the Fed will have to be tighter longer until they’re really confident that they’ve got inflation under control again.”
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Wall Street’s record for year-end forecasts of the bond market has taken a hit. Forecasts by Barclays, Goldman Sachs and other big banks in late 2021 largely failed to predict that the carnage markets would continue this year, causing the ICE BofA US Treasury Index (.MERG0Q0) to slip 13%, its biggest loss for the year in Fed history means rapidly raising interest rates to thwart rising inflation.
Banks forecasting a fall in the benchmark 10-year yield over the next year include Deutsche Bank, which sees the year-end yield at 3.65%, and Bank of America, which expects a year-end yield of 3.25% . Investors in futures markets believe the Fed will start cutting rates in the second half of the year, although the central bank has forecast interest rates to rise steadily through the end of 2023 and be about 70 basis points above current levels.
Several global and domestic developments complicate the case for lower yields. China’s rollback of strict COVID-19 guidelines could support global growth and ease a widely expected recession. It also threatens to push up inflation.
While the pace of US inflation eased in October and November, relatively resilient employment and other signs of economic strength suggested the Fed may have room for further monetary tightening.
“If the overall economy doesn’t weaken further, particularly if China eventually reopens, inflation could potentially recover,” said John Vail, chief global strategist at Nikko Asset Management.
Investors are looking forward to a flood of data next week, including minutes from the Fed’s last meeting on Wednesday and the US December jobs report on Friday.
Signs of continued economic strength could stoke fears of inflation and reinforce the case for policymakers to keep interest rates high for longer. Conversely, investors could interpret weaker data as a sign that a recession is approaching and move into bonds, a popular safe haven asset.
Right now, the Treasury market is “still more focused on inflation than … recession,” said Matthew Miskin, co-chief investment strategist at John Hancock Investment Management.
“You have to be patient over the next few months because if you get whipped on this recent surge…and then miss out on all the downside to returns, that would be the worst case scenario,” he said.
Matthew Nest, head of active global fixed income at State Street Global Advisors, believes yields are likely to fall in 2023. In the short term, however, its current uptrend could continue, pushing the 10-year yield to a test of 2022 highs around 4.25%, he said.
“The next big move is likely to be a fall in yield,” he said. However, “you may experience short-term pain.”
Reporting by Davide Barbuscia; Edited by Ira Iosebashvili and David Gregorio
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