US government bond yields keep ticking higher. What are bond markets trying to convey? And should investors be listening?
- Growth has been resilient in the US, with economists expecting the next GDP reading to show growth above 4%
- While the US economy has been surprisingly strong, the consumer is unlikely to keep going indefinitely.
- Treasury yields are likely to stabilise at 5-5.25%.
The US 10 year bond yield squeaked above the symbolically important 5% level last week. There have been a number of reasons suggested for this rise, from a glut of issuance, to a buyers’ strike, but the real worry is that the Federal Reserve is gearing up to raise rates again, just as investors thought it had come to an end.
It is easy to see why this fear exists. Growth has been resilient in the US, with economists expecting the next GDP reading to show growth above 4%, compared to 2.1% in Q2. The US consumer continues to drive the economy forward, even in the face of higher fuel costs and a depleted pandemic savings pot.
The question for investors is whether this fear is overdone – and therefore represents an opportunity to buy bonds – or whether it is justified, in which case yields could go higher still. While the US economy has been surprisingly strong, the consumer is unlikely to keep going indefinitely. Student loan repayments re-started in October, the store of pandemic savings is nearly exhausted and the impact of higher interest rates is only just starting to kick in.
Jack McIntyre, portfolio manager at Brandywine Global, believes that Q4 will look very different to Q3: “the rate hikes, loan growth slowing and quantitative tightening (will) all have a more meaningful impact on the economy, slowing it down and therefore bringing inflation down”. He believes treasury yields are likely to stabilise at 5-5.25%.
His view is that while the backup in yields has been painful, it is setting a stage for fixed income to do well over the coming years: “The state of the asset class has improved immensely and that’s not to say yields can't move higher, but this is not a major 1960s/ 70s style regime shift in fixed income and inflation, because there's way too much debt out there to withstand a significant move higher in yields from current levels.”
The 10 year treasury note has never generated negative returns for three years in a row. While it is not impossible that this should happen, it seems unlikely. If it did, it may make the opportunity even greater in 2024. Certainly, it makes government bonds look increasingly competitive with equities, where valuations look far more optimistic.
