(Bloomberg) — Wall Street’s slogan has been that 2023 is the year of the bond. Instead, fund managers have to deal with one of the most difficult years ever.
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Lacy Hunt, the 81-year-old chief economist at Hoisington Investment Management Co., who has analyzed markets, Federal Reserve policy and the economy for about half a century, says it was the most difficult of his entire career.
HSBC Holdings Plc’s Steve Major says it was “wrong” to assume the growing supply of U.S. government bonds didn’t matter. Earlier this month, Morgan Stanley finally joined Bank of America and took a neutral position on government bonds.
“It’s been a very, very humbling year,” Hunt said. A 13% year-to-date loss for the firm’s Wasatch-Hoisington US Treasury Fund comes on top of a 34% decline in 2022, data compiled by Bloomberg show.
Treasury bonds fell on Monday as worries eased that the war between Israel and Hamas could escalate and spread to other countries in the Middle East. The U.S. 10-year bond yield rose nine basis points to 4.70%. That’s more than 80 basis points more than at the start of 2023.
Last year’s big losses were easier to explain to customers – everyone knows that bond prices suffer when inflation is high and central banks raise interest rates.
In 2023, the U.S. economy was expected to collapse under the weight of the sharpest interest rate hikes in decades – bringing gains for bonds in anticipation of impending monetary easing.
Instead, employment data and other key indicators of the economy’s health remained strong despite slowing inflation, so the threat of faster price growth remained ever-present. Yields catapulted to highs not seen since 2007, putting the Treasury market on track for an unprecedented third year of annual losses.
The story goes on
And without the Federal Reserve buying bonds on the market to keep borrowing costs low, the U.S.’s massive deficits — and the rising emissions needed to contain them — now matter in a way they didn’t before.
Hoisington’s Hunt and his colleagues constantly debated whether they should fundamentally change their positive view of long-term debt because their assumption that slowing inflation would lower yields was not borne out. At the beginning of the year they reduced their duration, but not enough.
“We thought inflation would go down, and that’s what happened,” Hunt said. “In fact, there has never been such a sharp decline in inflation in the past that was not accompanied by a recession as an immediate consequence. So the fact that gross domestic product is still rising is unprecedented.”
At the same time, it is the expectation of a decline at some point that is keeping Wall Street’s beleaguered bulls from retreating too far as they try to manage their so-called restricted funds, which can only invest in the Treasury market.
“A hard landing is coming,” Hunt said.
Attractive levels
Bob Michele, chief investment officer of fixed income at JP Morgan Asset Management, reduced the overweight he had built in Treasuries as 10-year yields hit 4.30%. Since then, they have risen by more than 50 basis points. While current levels look attractive, the 40-year bond market veteran is waiting for the dust to settle.
“We have to respect the technicalities of the market and wait and see where this can play out,” said Michele, who earlier this year predicted that yields could fall as low as 3% across the curve by August. If longer-term yields rise above 5.25% and the labor market remains stable, it’s time for a real pullback, he said.
A year that was touted by companies like Vanguard Group Inc. and private equity giant KKR & Co Inc as the point at which Treasury bonds will bounce back – an “anchor in the storm,” as Michele said at the time – the reality is sobering. Since April, the yield on 10-year government bonds has recorded continuous monthly increases.
And while the bond market recouped some losses last week, it is being fueled by traders looking for the least risky assets as the war between Israel and Hamas fuels fears of escalation. Behind the gains, underlying uncertainty has not gone away, as the Fed has signaled that the next rate change could be a hike.
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Of course, a turnaround now would be costly: Many long positions were opened when yields were at 3.75%, according to data compiled by Jefferies International.
And even after bonds have collapsed, there are still metrics that suggest investors can wait even longer. The so-called yield-duration ratio – a measure of how much bond yields would have to rise to wipe out the value of future interest payments – is around 89 basis points.
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Despite the move to shorter maturities, Mike Riddell, portfolio manager at Allianz Global Investors UK Ltd., is still “very bullish on bonds.” For Aliki Rouffiac, who manages multi-asset portfolios for Robeco, higher yields increase the risk of an economic hard landing, which is why she uses bonds to hedge against a possible prolonged decline in stock prices.
“It’s been a difficult three years,” said Chris Iggo, chief investment officer of core investments at AXA Investment Managers. “The market has given doubters more reasons to question the value of fixed income. However, let me be bold. Next year will be the year of the bond.”
– With assistance from Garfield Reynolds and Sagarika Jaisinghani.
(Updates bond movements in fifth paragraph.)
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