A return to lower yields has been every bond fund manager's dream since the nightmare of 2022. But now, with expectations dashed that they’d get their wish this year, it appears they’ll have to hang their hopes on 2025.
Last Friday's bumper US non-farm payroll report is just the latest in a succession of head fakes over where we might be in the US economic cycle. The biggest fallout since has been in the shortest maturities, wiping as much as 50 basis points off Federal Reserve rate-cut expectations. Only a 25 basis point move is now priced in for the next Fed meeting Nov. 7 and one less rate cut in 2025. It's been a proper repricing, not aided by the impending presidential election and rising geopolitical uncertainty. So risk reduction is uppermost until clarity emerges. Certainly there is little stimulus coming from the rest of the world.
A key metric for bond bulls is that corporate credit spreads are showing little signs of widening. Coupon income has held up well for aggregated fixed-income funds, so total returns this year are positive — if (again) only a fraction of equity performance. Fixed income has always been the less showy vehicle for hedging risks compared to the animal spirits of stock markets. These reliable virtues shine in more difficult times. Bonds are into the value zone with the US Treasury coupon yield curve hugging either side of 4%, offering a positive return over inflation that’s back down near 2%. It might be too soon to say bonds are looking cheap, but they’re getting there. The US stock market and economic expectations have a lot of high hopes embedded.
US 10-year yields have climbed 40 basis points since the Fed’s aggressive 50-basis point starter rate cut on Sept. 16. That's the exact opposite of what the textbook reaction normally might be, brushing off repeated promises of more reductions to come. Importantly, this selloff is led by nominal rates, as the real yields of 10-year Treasury inflation-protected securities have risen half those of conventional bonds.
This suggests more of a positive growth shock that has led to positioning-led selloff flocking to more attractive asset classes elsewhere, rather than by sudden fears of resurgent inflation. There is nothing, as of yet, in any of the inflation data to suggest that may happen. The volatility of recent bond yield shifts also reduces the appeal of what is usually perceived to be a tranquil haven.
