This has been a year of unexpected investment twists and turns, especially in the world’s largest bond market. As recently as Tuesday, a Bloomberg gauge tracking returns in the Treasury market has shown a marginal year-to-date loss of 0.1% — a significant recovery from the 3.4% loss experienced in April.
Several factors have contributed to this recovery. Investors are increasingly betting on cooling US prices, which could prompt the Fed to lower interest rates sooner and more aggressively than anticipated. This expectation has put a cap on the potential rise of Treasury yields, making bonds a more attractive investment option.
Stephen Miller, an investment strategist at GSFM in Sydney: “We’ve seen the peak in yields. Bonds are now back as having a deserved place in a multi-asset portfolio.”
The Federal Reserve’s monetary policy has played a pivotal role in shaping the bond market’s trajectory this year. Policy-sensitive two-year yields surged past 5% in April as investors, anticipating persistently high Fed rates, sold off bonds. However, recent inflation and retail sales data, suggesting a possible slowdown in the US economy, have triggered a reversal of this trend.
Two-year yields have now retreated below 4.75%, and traders are factoring in about two quarter-point rate cuts from the Fed this year, with the first one fully priced in for November.
Investment Strategies and Opportunities
The current market conditions present a unique opportunity for investors to re-evaluate their bond portfolios. Rachana Mehta, co-head of regional fixed income at Maybank Asset Management, suggests that the Treasury 10-year yield, currently fluctuating between 4.2% and 4.5%, offers a good entry point for investors.
Speaking on Bloomberg Television, Mehta stated, “The volatility we saw in the past, hopefully it has died down given the recent US data. You can continue to be long duration at about 4.4% to 4.5% in 10-year Treasuries.”
As market expectations and the Fed’s outlook on rate cuts converge, the volatility in the $27 trillion Treasury market has declined. This reduction in volatility further strengthens the case for investing in bonds.
However, not all market participants share the same optimism. Strategists at Barclays have recommended shorting the 10-year note, anticipating a rebound in US economic activity. Swaps traders, on the other hand, see a more than 60% chance of a Fed rate cut as early as September.
The release of the Fed’s preferred inflation gauge, the personal consumption expenditures core price index (PCE), on June 28th, will be a key event to watch. If the PCE index falls to an annualized pace of 2.6% in May, as predicted by economists, it could solidify expectations for a rate cut in September and potentially push the 10-year Treasury yield towards 4%.
Corporate bonds have outperformed Treasuries so far this year, generating an excess return of 1.32% over their government counterparts. However, this excess return has declined from a peak of 1.74% at the end of May, as signs of economic weakness have increased credit risks, particularly among weaker borrowers.
The Treasury market’s recovery in 2024 underscores the importance of staying informed and adaptable in the face of evolving market conditions. While risks remain, the current landscape presents compelling opportunities for investors who are willing to re-examine their assumptions and embrace the potential of bonds in a diversified portfolio.
And of course we prefer yield stocks. My Value Authority portfolio now pays an annual dividend of 6.8% . . . easily 2 points higher than even the longest-term Treasury debt and a full point above most money markets or CDs. Who wouldn’t want that?
As a bonus, the stocks look eager to appreciate. Most are depressed, which is why the yields are so high. But the difference is clear: while bond yields are fixed when the paper is issued and are now coming down, good companies can increase their dividends over time.
Who wants to settle for a low positive rate of return if it never changes? I want to stay open to the upside.