Bonds suddenly look like smart hedges again after 12% loss
(Bloomberg) — A few brave souls in the investment world are starting to return to bonds to ride out an impending economic storm.
While debt bulls on Wall Street have been crushed all year, market sentiment has shifted markedly over the past week, shifting from inflation fears to growth. This theme was reinforced on Monday, when data showing a sharp contraction in the Chinese economy triggered brief gains for Treasuries.
Market expectations for price growth in the US have fallen from multi-year highs and nominal yields in the US, Germany, Italy and the UK have retreated from recent highs. Last week’s report showing higher than expected price hikes for US consumers failed to spark a sustained rout – a sign of bear market exhaustion after a historically poor start to the year.
With inflationary pressures still rampant everywhere, no one is betting with conviction that yields in any of the world’s major markets won’t rise again. But the argument is that the asset class still offers powerful cover as the Federal Reserve’s aggressive tightening campaign threatens to cause a downturn in the business cycle that could spill over to global assets.
“We’ve just started buying Treasuries,” said Mark Holman, a partner at TwentyFour Asset Management, a London-based investment firm specializing in fixed-income securities. “I’m pretty glad Treasury yields have gone up so much because I know we’re going to need it because we’re late in the cycle.”
Pacific Investment Management Co. chief investment officer Dan Ivascyn told the Financial Times that investors should “prepare” to buy trading bonds. He pointed to opportunities in higher quality assets such as mortgage bonds, investment grade corporate bonds and bank debt, particularly from US lenders.
Developed equity and credit markets have fallen this month with economically sensitive transactions in the firing line, helping to boost the biggest Treasury influx since March 2020. While German bunds have rallied strongly lately, they look more vulnerable given that the European Central Bank’s tightening campaign has yet to begin. But that’s not stopping strategists like Citigroup Inc. from seeing a reversal in Bund selling at the moment as growth is all about inflation expectations.
“Government bonds can start offsetting risk elsewhere,” said Howard Cunningham, fixed income manager at BNY Mellon Investment Management. “We’re not betting the rise in yields will reverse, but government bonds can start to do their thing.” Now you have a negative correlation with stocks from time to time.
US government bonds have already lost 8.8% this year through the end of last week, putting them on track for their first consecutive annual declines in at least five decades, according to a Bloomberg index. A global gauge is down more than 12%. Yet the 10-year Treasury yield has fallen 30 basis points since hitting 3.20% on May 9, its highest since 2018. At the same time, stocks have fallen sharply amid fears about growth, exacerbated by the war in Ukraine and the Covid shutdowns in China.
Deutsche Bank AG’s Gary Pollack warns that the Treasury sale is not over given ongoing price pressures, from rental costs to airline fares.
“As we expect inflation to fall, the question is, will markets be happy where they settle?” said Pollack, head of fixed income for Private Wealth Management. “That’s why I’m a little reluctant to say let’s buy here.”
US 10-year yields stabilized on Monday after falling four basis points to 2.88% in Asian trading after China announced that industrial production and consumer spending had fallen to the worst levels since the pandemic. . A look under the hood of the derivatives market suggests hedge funds are unwinding bearish Treasury exposures.
Candriam and AXA Investment Managers are among the firms that see US debt as a better bet than Bunds at the moment. Implied market expectations suggest the Fed will start cutting rates as early as 2024, after raising the funds rate to just over 3% next year.
“We are starting to think about buying Treasuries,” said Nicolas Forest, global head of fixed income at Candriam. “US yields are more fairly priced as the bull cycle is already underway. We are definitely lagging in Europe. The German two-year rate, around 0.15% on Monday, is ‘too low’. given the deposit rate could be 0.25% by the end of the year, he added.
The ECB is only expected to start raising rates in July and traders don’t see cuts for at least the next four years. On this trajectory, US bond prices would get a significant boost from an easing cycle by the Fed at a time when Bunds are facing a headwind from tighter monetary policy.
This is also a negative point for Italian bonds. BNY IM recently increased its short position in Italian bond futures as the ECB gradually exits the era of easy money, while BNP Paribas SA advised against a long position. Italian bonds led the euro zone declines on Monday.
Bonds in Europe could still offer opportunities for Mark Healy, portfolio manager at AXA Investment Managers. He thinks the UK looks like a relatively safe place at the moment, given that the Bank of England’s tightening campaign is underway.
“We would favor the UK the most, then the US and then Europe, although we would probably pull back a bit in terms of the number of ECB hikes,” Healy said. “So further down the road, European government bonds could offer value.”
–With help from Edward Bolingbroke and Garfield Reynolds.