U.S. government bonds just suffered their worst quarter in the past half-century: Here’s why some investors may not be fazed

US government bonds have just completed their worst quarter since at least 1973, but some investors are unlikely to be deterred from buying Treasuries again given the growing risks of a US recession over the next few years.

A model created by Goldman Sachs GS,
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predicts a 38% chance of a slowdown within 12 to 24 months, compared to virtually no chance next year. The path of overnight index swaps, along with a generally flat Treasury yield curve that inverted on Tuesday and Friday, also point to the prospect of an economic slowdown over the next two years.

The growing odds of an economic slowdown favor holding government bonds, as well as holding cash, while making riskier assets like stocks and commodities less attractive, analysts said. This suggests that the bond market four-decade bull run, which some investors said ended last year, may be only slowly running out of steam.

In a chart: ‘The Dam Has Finally Burst’: 10-Year Treasury Yields Peak to Break Top of Downtrend Channel Seen Since Mid-1980s

U.S. government bonds fell 5.6% in the first quarter, the worst performance since recordkeeping began in 1973, according to the Bloomberg US Treasury Total Return Index. And the 10-year Treasury note just finished its seventh worst quarter since the American Civil War, according to Deutsche Bank’s Jim Reid, citing data that includes equivalents of the 10-year note since 1865.

Read: US government bonds suffer one of their worst quarters since the Civil War

Source: FHN Financial, Bloomberg Total Return Indices


“Historically, when we’ve had bad quarters, the next quarter tends to be pretty good,” FHN Financial chief economist Chris Low said over the phone. “The difference with bonds, compared to equities and commodities, is that bond prices cannot fall indefinitely. If they did, the economy would eventually stop working. Eventually, they correct themselves.

Many of FHN’s clients are “holding unusual, if not record, amounts of cash” following the first-quarter bond carnage, Low said. Although there may be some decline in demand for bonds in the future, the “violent” sale of Treasuries should not deter portfolio managers of institutional, pension and insurance funds, which are under pressure to match benchmarks and cannot sit on too much money for extended periods, he says.

Bonds, a traditional safe haven, are the asset class hardest hit by high inflation, which is eating away at fixed returns. The aggressive liquidation of public debt in the first quarter is therefore not too surprising given that US inflation is at its highest level in four decades.

What’s surprising is that potential buyers aren’t necessarily discouraged by this fact or the recent selloff, analysts said. Although the sell-off stung existing bondholders, it offers potential investors the opportunity to return to relatively lower prices and higher yields than at any other time in recent years.

“There is a need for yield,” said Rob Daly, fixed income director at Glenmede Investment Management. “The bond market doesn’t necessarily provide inflation-adjusted returns – in fact, real returns are quite negative as inflation remains high – but you have to strike a balance between risky assets and safe havens.

“There will be a time when buyers return to bonds, but the severity of their return is a question mark,” Daly said in a phone interview. “The market is trying to figure out when and why to buy in the bond market.”

The record first quarter bond sale was accompanied by a substantial rise in market-based interest rates, contributing to a slowdown in the housing sector and hurting equities and commodities. The three major DJIA SPX COMP stock indices ended the first quarter on Thursday with their biggest percentage decline in two years.

Request mortgage refinance has dried up, pending home sales are down, and housing goods companies like mattress maker Tempur Sealy International Inc. TPX,
+0.47%
have issued sales warnings. Meanwhile, “the cost of funding is rising, eroding potential returns and weighing on growth” – all of which affect stocks – while cash remains “a valuable asset as there is no safe place to be. right now,” said Daly of Glenmede.

Read: ‘The housing market is in the early stages of a substantial slowdown’: Home sales could drop 25% by the end of summer, according to this analysis

Continued interest in bonds going forward would put pressure on yields and prevent them from rising more than would normally be the case. The end result would be a back and forth between buying and selling – similar to what’s been seen this week – that lets investors adjust to higher interest rates and keeps yields from climbing too high. far.

In an email to MarketWatch, rates strategist Bruno Braizinha at B. of A. Securities, said it was safe to say that the 10-year Treasury TMUBMUSD10Y,
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will reach a “relatively low” yield peak in the current economic cycle of around 2.5% or slightly above – not far from where it is currently.

That’s not much given that Federal Reserve officials are seen as likely to offer an above-normal interest rate hike of half a percentage point in May, along with a series of hikes until in 2023, while also trying to shrink the central bank’s balance sheet. Traders are pricing in a slight chance that the Fed’s main policy rate target could rise above 3% by the end of the year, falling from a current level of 0.25% to 0.5%.

“If you believe what the OIS curve and trajectories are telling you, you should expect portfolios to be more conservative on both tactical and strategic asset allocation profiles” targeting six months to one year and up to three years, Braizinha said. This means Treasuries “are likely to remain supported” even if the Federal Reserve pulls out of the bond market as a buyer.

Yet high inflation “changes the usefulness of Treasuries as a risk hedge for portfolios, so PMs (portfolio managers) will need to be more creative in how they hedge tail risks,” did he declare. “We recommended using options in addition to traditional long-lasting covers.”

Next week’s US economic calendar is light, but highlighted by Wednesday’s release of the March 15-16 Fed meeting minutes. Monday brings February factory orders and basic equipment orders. On Tuesday, data is released on February’s trade deficit, S&P Global’s final reading of March’s services sector purchasing managers’ index and the Institute for Supply Management’s services index for March.

Thursday brings weekly jobless claims and consumer credit data for February, followed by a February wholesale inventory report on Friday.

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