Some of the biggest bond managers are sticking to their bullish view on the market for US government debt, even as that trade looks riskier by the day.
Brandywine Global Investment Management, Columbia Threadneedle Investments, and Vanguard Group Inc. are keeping the faith that a rousing fixed-income rally is coming, a stance that is being sorely tested by the economy’s resilience and the Federal Reserve’s eyeing of higher interest rates.
Other market-watchers aren’t so sure: JPMorgan Chase & Co. strategists last week ditched a recommended long position in five-year Treasuries
It was supposed to be a banner year for fixed income amid assumptions the Fed would be pivoting to cutting rates by now, unleashing a ferocious rally that would erase some of the historic losses of 2022.
But a solid job market and sticky inflation spoiled that narrative, burning the bets that monetary policy would be eased.
As a result, the average bond manager has seen only a modest rebound in 2023, buoyed mostly by income from some of the highest yields in years, leaving the steadfast bulls to bide their time until the economy falters.
“There was a lot of talk about the year of the bond, but don’t be surprised if it’s the year of the coupon,” said Jack McIntyre, a portfolio manager at Brandywine.
As it was in January, the $2.1 billion Global Opportunities Bond Fund he helps manage is still favoring longer-dated Treasuries and emerging-market debt, a stance that will benefit from the richer income streams, with the portfolio as a whole poised to perform better if a recession looks likely. It is, McIntyre concedes, an allocation that will not fare well if the economy and inflation heat up again.
“We are not positioned for that outcome,” he said.
Camping Out
That risk was front and center last week when unexpectedly strong data on jobs and economic growth on June 29 drove short-maturity Treasury yields to one of their biggest daily increases since March.
It’s the kind of volatility that some managers are eager to avoid. They’re content to camp out in cash, with ultrasafe Treasury bills yielding above 5% for the first time in more than a decade.
The bond bulls, however, are reluctant to throw in the towel. They say it’s a question of waiting for Fed rate hikes to take full effect. With more tightening likely as soon as this month, there’s also the risk of market tumult ahead, as seen in March when the crisis involving regional banks drove a Treasuries rally.
“The bonds-are-back narrative still holds — they have attractive coupons and fixed income offers ballast to a portfolio, and as you saw in March, if things go badly, bonds can rally a lot,” said Roger Hallam, global head of rates at Vanguard Asset Management. Vanguard Group oversees $880 billion in active bond strategies.
“Cash yields are not durable,” he said. “And a change in the macro environment means you don’t have high returns locked in.”
Pivotal Debate
The timing of that change is at the heart of the debate in markets now: The tailwind from fiscal stimulus and still-robust consumer spending will continue to challenge the current bond-market consensus that the economy is poised to founder in the face of higher rates.
“The market still prices in recession-type cuts for ‘24 and ‘25,” and that helps keep longer-dated Treasury yields below 4%, said Hallam. The threat to that view, he says, would come from evidence that housing is rebounding and that the economy can withstand the Fed’s tightening.
Over at Columbia Threadneedle, Gene Tannuzzo says the firm remains where it began the year — overweight the 10-, to 30-year area of the Treasury curve — and is prepared to wait out the months ahead.
“For the rest of 2023, I put my chips on the Fed to deliver two more rate hikes,” said the global head of fixed income at the firm, which manages $225 billion in bonds, mostly in active strategies. “But for 2024, I put my chips on the market that the lagged effects of tightening mean the Fed will cut.”
Ultimately, bond performance rests on the data and how long the Fed keeps rates above 5%. As Brandywine’s McIntyre points out, for the bulls biding their time there’s at least some comfort in the level of income streaming their way.
“The good news is unlike last year and the previous decade when time didn’t work in your favor, this year it does work thanks to the higher bond coupon.”
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