Bond managers see opportunity with yields below Fed rate

(Bloomberg) — A sense of belief that bonds should be bought is helping fund managers put the worst year in a generation behind them.

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Even though the Federal Reserve has made it clear that it intends to raise rates further to ensure a continued rise in inflation, and that it is not considering the possible rate cuts that traders expect, the investors are already being rewarded for seeing value in the Treasury market. With this week’s rise to 4.25%-4.5%, the central bank’s range for the fed funds rate is overtaking the highest-earning Treasuries – a warning to investors against the longer wait for buy.

On several occasions this week, intraday yield spikes have quickly dissipated, a sign that buyers are jumping on them. The first came after the Fed’s decision on Wednesday, spurred by policymakers’ upward-revised median forecasts of an eventual spike in the key rate and inflation. Over the next two days, a sell-off in eurozone government bonds triggered by hawkish comments from the European Central Bank caused only a temporary drop in US rates. A sharp drop in Treasury volatility this week after the Fed’s decision bolstered investor confidence that yields will not hit new highs.

Interest in buying bonds reflects the view that inflation has likely peaked and will fall sharply, although the Fed is not ready to draw that conclusion. In addition, the four percentage point increase in the key rate since March sows the seeds of a recession that will eventually lead to rate cuts, if not in 2023 at least in 2024.

“We think the outlook for 2023 is starting to brighten,” said Marion Le Morhedec, global head of fixed income at AXA Investment Managers SA. The rate hike we’ve seen this year “adds to the attractiveness of the bond market” and central bank tightening “seems to be largely behind us.”

With the exception of two-year bonds — more sensitive than longer-dated yields to the level of the Fed’s key rate — rates across the Treasury spectrum are back below 4%. The two-year peaked at nearly 4.80% last month, the ten-year near 4.34% in October, both multi-year highs. The corresponding fall in bond prices has wiped up to 15% off the value of the Bloomberg Treasury Index this year. Although the loss was reduced to around 11%, it was still the worst in the index’s five-decade history.

The yield on the 10-year note approached 3.40% this month, helped by signs of moderating inflation in the Consumer Price Index reports for October and November, and Fed Chairman Jerome Powell signaled the central bank’s slowing pace of rate hikes with its half-point hike. the dec. 14.

Admittedly, the fall in yields from their highs raises the stakes for investors who think now is the right time to buy. New median forecasts from Fed policymakers released after this week’s meeting showed they expect a higher peak for the federal funds rate of 5.1% next year to weather a expected increase in underlying inflation of 3.5%.

Powell, at the press conference following the meeting, pointed out that, as the labor market has not yet shown significant signs of slowing, it is unclear how long the key rate will have to remain at its peak. possible. Meanwhile, policymakers’ median forecasts for 2024 include a funds rate cut to 4.125%.

“A 10-year at 3.5% looks a little too low, but at the same time it’s hard to see any upward pressure on government bond yields when inflation starts to cooperate,” Andrzej said. Skiba, Head of BlueBay US Fixed Income at RBC Global Asset Management.

Next week’s personal income and spending data for November is expected to show a decline in the underlying inflation rate to 4.6%, the lowest since October 2021. The December sentiment survey the University of Michigan, which will be revised next week, revealed that consumers expect 4.6% inflation over the next year, also the lowest in more than a year.

Market-implied inflation expectations also declined, with the equilibrium rate on five-year Treasury inflation-protected securities approaching year-to-date lows around 2.20%. That suggests investors are confident the Fed will be successful in battling the CPI rate, at 7.1% in November, down from its peak of 9.1% in June.

San Francisco Fed President Mary Daly said on Friday that the central bank remained far from its goal of price stability and had “a long way to go.” Bond traders were not fazed.

Seasonal dynamics complicate the analysis, however, said Michael de Pass, head of linear rates at Citadel Securities.

The bullish tone in the bond market “may reflect year-end flows as money moves into bonds amid low liquidity,” he said.

But after 400 basis points of rate hikes, a hawkish Fed no longer poses the same degree of danger to bond investors as before, leading them to draw different conclusions.

“The Fed has largely caught up with the situation on the ground,” de Pass said. “The market thinks the economy and the labor market are going to deteriorate much more than the Fed.”

What to watch

• Economic calendar:

  • Dec. 19: NAHB Housing Market Index

  • Dec. 20: Housing starts

  • Dec. 21: MBA mortgage applications; current account balance; Sales of existing houses; Conference Board Consumer Confidence

  • Dec. 22: final revision of GDP in the 3rd quarter; weekly jobless claims; Advanced index; Kansas City Fed Manufacturing Activity

  • Dec. 23: personal income and expenses; durable goods orders; sales of new homes; University of Michigan Sentiment Survey

• Fed calendar:

• Auction schedule:

  • Dec. 19: 13 weeks; 26 week invoices

  • Dec. 21: 17-week bills; 20 year bond

  • Dec. 22: 4-week, 8-week bills; 5 years of advice

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