As bonds recover from a major selloff, some investors predict stronger conditions in the United States fixed income market in 2024 — that is, if the rate cuts by the Federal Reserve occur as expected.
After the worst-ever drop one year ago, a rally in the fourth quarter spared bonds from a record third straight annual loss in 2023. The end-of-year rally occurred after Treasuries fell to their lowest point since October 2007.
Expectations that the Federal Reserve is probably done increasing rates and will reduce the cost of borrowing next year drove those gains. This belief gained momentum when policymakers surprisingly included a 75 basis point easing in their economic forecasts of December in response to signs that inflation was continuing to decline.
Falling interest rates are predicted to drive down Treasury yields and raise bond prices, a development that most investors are expecting. According to the most recent BofA Global Research fund manager survey, investors have the largest overweight bond position they have had since 2009.
However, not everyone thinks that the way to lower yields is easier. Some fear that the over 100 basis point drop in Treasury yields since October clearly indicates market expectations for rate reductions, making markets susceptible to pullbacks should the Fed does not cut rates quickly enough.
Futures linked to the Fed's key policy rate show that the market has priced in cuts of about 150 basis points for next year, which is twice as much as policymakers have budgeted for. The yield on the benchmark 10-year Treasury was just 3.88% last week, the lowest since July.
A lot of people are also keeping an eye out for the resurgence of the budgetary concerns that propelled yields to their 2023 highs but subsided in the latter half of this year.
Bonds come back
The Bloomberg US Aggregate Bond Index indicates that as of last week, US bond returns so far this year, which take into account price fluctuations and interest payments, were 4.8%, as opposed to a negative 13% in the previous year.
In a report released earlier this month, Vanguard declared that bonds come back.
In contrast to its previous expectations of 1.5% to 2.5% prior to the start of the rate-hiking cycle last year, the second-biggest asset manager in the world projects a return on US bonds of 4.8% to 5.8% over the next ten years.
While not everyone anticipates a recession, most bond bulls believe that the US economy will grow more slowly and that inflation will decline, which will pressure the Fed to lower interest rates.
As yields rise in 2023, fixed income can provide investors with both income and the possibility of capital growth, according to Eoin Walsh, partner and portfolio manager of TwentyFour Asset Management.
By year's end, he anticipates that 10-year yields will range from 3.5% to 3.75%.
Some others think the Treasury yield curve has perhaps rallied too far.
According to BlackRock's Chief Investment Officer for Global Fixed Income, Rick Rieder, the latest rally has made both longer- and shorter-dated bonds highly valuable. He stated that a large portion of the 2024 return, both for the front and the back end, has already been realized.
In addition, worries about large budget deficits and anticipations of more bonds being issued may raise term premiums, or the compensation investors require to assume the risk of owning long-term bonds. Demand may slow down in the interim as the Federal Reserve and significant foreign purchasers, like China, reduce their holdings of Treasury bonds.
Financial conditions, which is an indicator of how much money is available in an economy, have also been eased as a result of the latest bond rally. Some fear this could delay the Fed's rate reductions by boosting a growth rebound or even inflation.
The Goldman Sachs Financial Conditions Index had dropped by 136 basis points since late October and reached its lowest point since August 2022 on December 19.