A few brave souls in the investing world are starting to move back into bonds to ride out an oncoming economic storm.
While debt bulls on Wall Street have been crushed all year, market sentiment has shifted markedly over the past week from inflation fears to growth. That theme gathered more strength Monday, when data showing a sharp contraction in China’s economy sparked brief gains for Treasuries.
Market-derived expectations of US price growth have dropped from multi-year highs and nominal yields in the US, Germany, Italy and UK have retreated from recent peaks. Last week’s report showing higher-than-expected price increases for American consumers failed to ignite a sustained rout -- a sign of bear-market exhaustion after a historically bad start to the year.
With inflation pressures still rampant everywhere, no one is betting with conviction that yields in any of the world’s major markets won’t move higher still. But the argument goes that the asset class still offers a powerful hedge as the Federal Reserve’s aggressive tightening campaign threatens to spur a downturn in the business cycle that could ripple across global assets.
“We just started buying Treasuries,” said Mark Holman, a partner at TwentyFour Asset Management, a London-based investment firm that specializes in fixed-income securities. “I’m quite pleased that Treasury yields have gone up so much, because I know we are going to need them because we are late cycle.”
Pacific Investment Management Co.’s chief investment officer Dan Ivascyn told the Financial Times that investors should “get ready” to snap up bargain bonds. He pointed to opportunities in higher-quality assets such as mortgage bonds, investment-grade corporate bonds and bank debt, especially of US lenders.
Developed stock and credit markets have fallen this month with economically sensitive trades in the line of fire, helping spur the biggest Treasury inflow since March 2020. While German bunds have rallied sharply of late, they look more vulnerable given the European Central Bank’s tightening campaign has yet to kick in. But that’s not stopping the likes of Citigroup Inc. strategists seeing a reversal in the bund selloff for now as growth concerns trump inflation expectations.
“Government bonds can begin to offset risks elsewhere,” said Howard Cunningham, a fixed-income manager at BNY Mellon Investment Management. “We’re not betting that the rise in yields is going to reverse, but government bonds can begin to do a job. Now, you’ve got negative correlation with equities some of the time.”
US government bonds already lost 8.8% this year through the end of last week, putting them on course for their first back-to-back 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 dropped sharply amid fears over growth, exacerbated by the war in Ukraine and Covid lockdowns in China.
Deutsche Bank AG’s Gary Pollack warns the Treasury selloff isn’t over given persistent price pressures from rental costs to airline fares.