Bond investors who had defensively positioned their portfolios in expectation of a U.S. recession are changing their tactics to account for an unexpectedly resilient economy that is likely to keep interest rates higher for a longer period of time than they had anticipated.
In recent weeks, the idea of a “soft landing” economic path, in which the Federal Reserve controls inflation without forcing output to fall, has gained increasing traction, leading some investors to take on more risk or cut back on wagers that safe-haven assets like Treasuries would appreciate.
TwentyFour Asset Management’s portfolio manager for fixed income, Felipe Villarroel, announced that he was switching some allocations from 10-year Treasuries to 10-year investment-grade corporate bonds.This undoes an accumulation of 10-year U.S. government bond positions that began a year ago, when rates were rising as a result of the Fed’s interest rate hikes.
“The tail risk of a hard landing is being priced out, and that doesn’t mean we’re too bullish on the economy, but it does mean that the weighted average scenario has improved,” the economist added.
It has becoming harder for investors to stick to their calls when expecting greater economic turmoil. The unemployment rate has stubbornly remained low over the past year, and growth has routinely outperformed trend.
John Madziyire, senior portfolio manager and head of U.S. Treasuries and TIPS at Vanguard Fixed Income Group, predicted that the rate rally will take longer than expected. We have therefore decreased those roles and now anticipate them to occur much later than we had originally anticipated.
In times of economic weakness, treasuries typically gain in value and their yields fall, but long-term yields have risen recently, with the benchmark 10-year bond reaching a nearly 10-month high on Tuesday.
Bond investors are also taking into account the Bank of Japan’s recent change in its yield curve management policy, concerns about the sustainability of U.S. debt as emphasized by Fitch’s U.S. downgrade, and the sizeable funding requirements stated by the Treasury, in addition to pricing for greater economic resilience.
“Recession or no recession, we think the probability of higher-for-longer interest rates is far greater than the likelihood of near-term cuts,” says investment company Oaktree Capital
According to Anthony Woodside, head of U.S. Fixed Income Strategy at LGIMA, recent long-term concerns about the U.S. fiscal condition have increased 30-year Treasury bond yields by around 20 basis points.