It isn’t hard these days to find investors trumpeting the demise of the decades-long bull run in Treasuries.
But after the worst quarter since 1980, the bulls are ready to grab back some of the limelight. The result is that the debate about the next step in the world’s biggest bond market -- one with far-reaching implications for all asset classes -- is only intensifying.
On one side stand the likes of Bill Gross and Ray Dalio, who were among those declaring a bear market in 2018, when 10-year yields surpassed 3%, and who are again downbeat. For the other camp, including fund managers at Mitsubishi UFJ Kokusai Asset Management Co. and Northern Trust Asset Management, that’s all just noise. They say Treasuries are attractive on the view that inflation will remain tame and growth fueled by fiscal stimulus will fade.
It’s possible the bears have finally nailed it, with the Federal Reserve saying it will allow inflation to run hot for a bit, while unprecedented amounts of fiscal stimulus appear to be jumpstarting the rebound from the pandemic. Yet the bulls are resolute that there’s a long road to recovery, and they see paltry overseas rates stoking demand for Treasuries.
There’s even another take, in which neither side proves quite right -- Ben Carlson of Ritholtz Wealth Management says heightened volatility is the new reality, with the era of big trends essentially over.
Below is a collection of investors whose views capture the scope of the debate. They spoke as 10-year yields have retreated from pre-pandemic heights near 1.8%, and with inflation expectations near multiyear highs. Meanwhile, traders are assessing the tax proposals in the next U.S. stimulus plan, a likely key to the path of Treasuries, and potentially all markets, for the rest of 2021.
The Bulls
Akio Kato, a portfolio manager at Mitsubishi UFJ Kokusai, which manages over 17 trillion yen ($155 billion), says Treasuries are appealing in part because of the Fed’s commitment to easy policy. The central bank is buying roughly $120 billion of Treasuries and mortgage debt each month combined. It’s also signaling that it won’t raise its policy rate through at least the end of 2023, even as the market is pricing in a more aggressive timing.
- “Around 1.7% could be a peak level after pricing in the potential U.S. economic recovery,” Kato said. “Fed policy makers have repeatedly said they will stick with their current monetary policy. If the market’s perception for the economic outlook comes closer to the Fed’s, 10-year yields could fall to about 1.5%.”
Peter Yi, director of short-duration fixed income and head of credit research at Northern Trust Asset Management, which oversees roughly $1 trillion, says they’ve been “opportunistically” buying Treasuries when yields rise. With millions still unemployed, he sees the broad-based recovery the Fed is seeking as years away, even after robust March jobs figures.
- “U.S. Treasuries at about 1.7% is a pretty good relative value compared to the S&P 500’s estimated forward dividend yield at just below 1.5%,” Yi said. “If rates get too high there will be a bite to risky assets and the economy, and the Fed will do something to prevent that.”
Steven Oh, global head of credit and fixed income at PineBridge Investments, which manages about $126 billion, says the climb in 10-year yields has pulled forward increases he expected over several years. When 30-year bonds reached around 2.5% last month, they became “tactically attractive,” he said.
- “We are of the view that we are going to continue to be in a lower inflationary environment both in the U.S. and globally,” Oh said. “Growth will pick up after Covid but it won’t accelerate to the point sufficient to cause a material rise in yields.”
Jim Leaviss, chief investment officer of public fixed income at M&G Investments, which manages 339 billion pounds ($465 billion), says the firm has been buying 30-year Treasuries in its multi-asset portfolios. A key for him has been the increase in long-term expected interest rates to levels that exceed the most hawkish projections from FOMC members for the longer-term fed funds rate.
- “It’s time to start scaling back into U.S. Treasury bonds,” he said. “There’ve been inflation scares over my entire career, but they’ve never come to fruition. And as such, I’ve always learned to hold my nerve, look through them and expect these things to be transitory.“
The Bears:
Susan Buckley, managing director for global liquid strategies at QIC Ltd. in Brisbane, which manages 85 billion Australian dollars ($65 billion), sees U.S. 10-year yields heading above 2% this year, a level last seen in August 2019.
- “We’ve seen a rapid increase in yields, even further and faster than we’ve expected from the end of last year,” she said. “As markets have gained greater confidence in the rollout of the vaccine, particularly the success in the U.S., economic activity continues to surprise on the upside. Yields will push higher from here.”
Ed Yardeni, founder of Yardeni Research Inc., says the 10-year yield will hit 2% potentially within the next few months and then 3% or higher by the end of next year. He bases that on the U.S. vaccine rollout and all the stimulus in the economy, which he expects to boost measures of growth to pre-pandemic levels. He’s also watching the jump in the ratio of the price of copper to gold -- an indicator of risk sentiment that has historically correlated well with yields.
- “Higher yields make a lot of sense given the extraordinary strength of the economy and mounting inflationary pressures,” he said. “Over the next few months economic indicators, particularly real gross domestic product, will probably return back to where they were before the pandemic.”
Luca Paolini, chief strategist at Pictet Asset Management, which oversees 242 billion Swiss francs ($262 billion) says the risk of inflation readings -- not just inflation expectations -- starting to tick higher is a concern.
- “It’s a problem for markets because it may force the Fed to tighten,” Paolini said at a webinar the firm held on March 31. “It may at some point even limit spending, because obviously the spending power will be eroded by inflation. There is a genuine risk of inflation surprising on the upside.”
Elaine Stokes, a portfolio manager at Loomis Sayles & Co., which manages about $348 billion, says the unknowns ahead are hard to handicap -- including how additional stimulus works through the economy. She sees 10-year yields rising just about 20 basis points to 50 basis points over the next year or two.
- “I don’t expect runaway anything,” Stokes said, referring to inflation, growth and yields. “A lot of the pain is already done and felt. And we have to remind ourselves that we are also going back to all the issues we were dealing with pre-Covid,” such as huge debt loads, demographic trends and technological changes, and trying to figure out how those forces may have changed.
Just Volatility:
Carlson, director of institutional asset management at Ritholtz, casts aside the notion of the big trends that characterized recent decades in Treasuries. His outlook is marked by bouts of volatility. More fluctuations may be in the offing in part because duration in the debt market is near a record high. That means that yield changes will cause bigger price swings, and potentially fuel quicker flows in and out of the market.
“We have all been conditioned to believe there are always these huge long cycles,” he said. “But we maybe are just going to have shorter cycles where there are spikes, and people come back in and yields move all around. That’s kind of the new regime.”
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