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Year-ahead outlook season is upon us again and the déjà vu vibe is strong. This time last year, investors and analysts were busy telling the world about their key convictions about 2023. Chief among them: the US was heading for a recession and the historic decline in government bond prices was over.
Now, you’ll be shocked to hear the key message for 2024 is that (sure, we got it wrong last time, but hear us out): the US is heading for recession and the historic decline in government bond prices is over.
The main tweak to the refrain is that in general the elusive recession is expected to be on the mild side — a slowdown rather than the so-called “hard landing,” the horror show that was widely expected at the start of this year. But most agree that next year will be the point when higher interest rates finally start to bite, boosting the allure of safe assets such as government debt. They really mean it this time.
Getting this call right is crucial not just to the bond market, but to all the other asset prices that use bond prices as an anchor. Analysts and investors are quick to admit this crucial task has thrown them off-course this year.
“Last year we saw a scenario that bonds are back,” said Vincent Mortier, chief investment officer at Amundi, Europe’s largest asset manager, at its outlook event this week. “We were a bit early.”
Just as investors were expecting a decline in bond yields, the market administered a beating. Benchmark 10-year US government bond yields swept up from a low point this year of about 3.3 per cent in April to 5 per cent in late October — the highest point since before the financial crisis.
Broadly, the consensus got its inflation call right. The pace of price increases in most major economies has declined sharply. But the peculiarities of the US mortgage market, in particular, mean that homeowners are shielded from the glare of higher borrowing costs for years. Corporate America is also not yet feeling the burn. Crucially, the fiscal largesse of the Biden administration has kept the economy humming. The consensus underestimated how long it would take for monetary tightening to bite.
At 5 per cent yields, Mortier said, those long-dated Treasuries were simply too good to miss; Amundi was among the many bargain hunters that bought at that level. Thinking somewhat longer term, he says, “now we’re more convinced than ever that high quality bonds are back as part of a portfolio”. He reckons a jump in prices will mean the US 10-year yield sinks to 3.7 per cent by the end of 2024, albeit on a potentially volatile path.
Similarly, UBS Wealth Management is encouraging clients to think about “locking in” the relatively high yields now on offer in expectation of a slowdown next year — plus the chance of rate cuts towards the end of 2024 that it had previously thought were possible around now. Leslie Falconio, head of taxable fixed income strategy, says slower growth will outweigh the potentially bond-weakening impact of a larger than usual supply of new debt hitting the market.
Several key issues are constraining the mood, however. One is humility — few will forget how easy it has been to make the wrong call this year, which means that now, “people have given up having strong views”, as Wolf von Rotberg, an equity strategist at private bank J Safra Sarasin put it.
In addition, investors are disarmed by volatility. Even those accustomed to the wild ride in rates markets over the past few years are taken aback by the scale of recent shifts — a round trip from 4 per cent yields in September to that peak at about 5 per cent and then a lot of the way back down again within six weeks is bracing, to put it mildly.
“The moves in bonds are so powerful, the volatility is so high . . . It’s just almost uninvestable,” said Greg Peters, co-chief investment officer at PGIM Fixed Income. “It’s hard to get true investors into the marketplace when volatility is so high, so you are left with highly sensitive marginal buyers like hedge funds and other folks, which creates more volatility.”
In addition, he said, the rapid turnaround in yields was enough to put a lot of long-term would-be buyers off because it suggested that, not for the first time, the market had got ahead of itself. Instead of simply pricing in a pause in US rate rises, it was already reflecting the chance of potentially aggressive rate cuts.
“The market has squeezed a lot of value out of 2024 already,” Peters warns, cautioning against any expectation of rapid rate cuts. “There’s this outdated playbook that investors are using, where they think that on any pullback in the economy, central banks will come running [with rate cuts].”
The weight of expectations is extraordinarily heavy. Bank of America’s regular survey shows that investors are running the third largest positive bet on bonds of the past two decades. In addition, a record 61 per cent of fund managers told the bank they were expecting lower yields in 2024. If that kind of weight of consensus does not give you pause, nothing will. This year still has plenty of time left to beat a bit of complacency out of the market, and it is dangerous to assume the bull market in “wrongness” is over.
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