Time running out for ‘year of the bond’ as losses mount

LONDON – The tag line from Wall Street was that 2023 was the year of the bond.

Instead, fund managers are coming to terms with one of the toughest years ever.

Mr Lacy Hunt, the 81-year-old chief economist at Hoisington Investment Management who has been analysing markets, Federal Reserve policy and the economy for around half a century, said it has been the hardest of his entire career.

At HSBC Holdings, Mr Steve Major said he was “wrong” to assume the United States government’s growing supply of bonds did not matter.

Earlier in October, Morgan Stanley finally joined Bank of America and moved to a neutral position on Treasuries.

Said Mr Hunt: “It’s been a very, very humbling year.”

A 13 per cent year-to-date loss for the firm’s Wasatch-Hoisington US Treasury Fund comes on top of 2022’s 34 per cent drop, data compiled by Bloomberg shows.

Treasuries fell on Monday as concerns eased that the Israel-Hamas war would escalate to engulf other countries in the Middle East.

The yield on 10-year US notes rose five basis points to 4.66 per cent.

That is nearly 80 basis points higher than where it started 2023.

The steep losses in 2022 were easier to explain to clients – everyone knows bond prices suffer when inflation is high and central banks are driving up interest rates.

The expectation in 2023 was that the US economy would crater under the weight of the sharpest run of hikes in decades – bringing gains for bonds on the expectation of policy loosening to come.

Instead, even as inflation slowed, jobs data and other key measures of the economy’s health remained strong, keeping the threat of faster price growth ever-present.

Yields catapulted to highs not seen since 2007, putting the Treasury market on course for an unprecedented third year of annual losses.

And without the Fed in the market buying bonds to hold down borrowing costs, the US’ massive deficits – and the ballooning issuance needed to plug them – now matter in a way they did not before.

Hoisington’s Mr Hunt and his colleagues constantly discussed whether to conduct a wholesale alteration of their favourable view on long-term debt, as their assumption that slowing inflation would curb yields failed to materialise.

They did trim their duration earlier in 2023, but not sufficiently.

“We thought that inflation would come down and it did,” Mr Hunt said. “In fact, there has been no decline that large in inflation that has not been involved with a recession in its immediate aftermath in the past. So the fact that gross domestic product is still rising is unprecedented.”

At the same time, it is the expectation that a contraction will eventually happen that is keeping Wall Street’s bruised bulls from retreating too far as they try to manage their so-called constrained funds that can invest solely in the Treasury market.

“A hard landing is coming,” Mr Hunt said.

Attractive levels

While the bond market has clawed back some losses in the past week, it is fuelled by traders hunting the least risky assets as the war between Israel and Hamas stokes fears of escalation.

Behind the gains, the core uncertainty has not gone away, with the Fed signalling that the next change in interest rates could be a hike.

To be sure, a U-turn now would be costly: Many long positions were opened when yields were at 3.75 per cent, according to data compiled by Jefferies International.

Despite moving to shorter maturities, Mr Mike Riddell, a portfolio manager at Allianz Global Investors UK, says he is still “very bullish on bonds”.

For Ms Aliki Rouffiac, who manages multi-asset portfolios for Robeco, higher yields increase the risk of an economic hard landing, which is why she is using bonds to hedge against a possible prolonged pullback in stocks.

“It’s been a tricky three years,” said Mr Chris Iggo, chief investment officer of core investments at AXA Investment Managers.

“The market has given the doubters more reasons to question the value of fixed income. Let me be bold, though. Next year will be the year of the bond.” BLOOMBERG