Bond traders envision worst real returns in decades



Investors in the Treasury lose more money than they have lost in four decades after controlling for inflation. And if the markets are right, they are unlikely to get away with it for years.

Federal government debt has already lost about 2% in the past year as the Federal Reserve began to pull pandemic-era stimulus from the economy and moved closer to rate hikes. ‘interest. But on top of that, the consumer price index jumped 6.8%, plunging investors even further into the hole.

Taken together, this translates into the worst real returns – or inflation-adjusted ones – since the early 1980s, when Fed Chairman Paul Volcker was battling a wage-price spiral. Additionally, the momentum is unlikely to change: The bond market predicts that 10-year Treasury yields will hold below the rate of inflation over the next decade, meaning any investment income will be more than wiped out by the rising cost of living. .

The consistently low level of long-term yields in the face of the highest inflation in decades has been a major headache on Wall Street, as it defies textbook expectations that investors will demand higher payments in return. In 1982, the last time year-over-year inflation rose as much as in November, the 10-year yield climbed to almost 15%. It’s less than 1.5% now.

Some say this reflects the deluge of stimulus and increased household savings since the start of the pandemic, which has left excess liquidity flooding the treasury market. For others, it reflects a pessimistic view of the economy, signaling that investors see the country’s growth potential continuing to slide as the population ages.

Either way, nearly two years of sub-zero real returns have penalized average savers and bond investors in favor of the federal government.

“People have been putting up with negative real returns for a long period of time,” said Greg Whiteley, portfolio manager at DoubleLine Group, which oversees $ 137 billion in assets. “Despite how odd it might sound, maybe it is something that we have to adapt to as a new normal. The centuries-old long-term drivers are still in place and they will always be powerful.”

Ten-year inflation-linked bond yields fell to an all-time low of minus 1.25% last month before rebounding to around minus 1%. Taken at face value, this shows investors expect 10-year yields – trading at 1.44% on Monday – to follow inflation by around 1% a year over the next decade. .

“You may not want to own bonds because they are [a] negative yield security, ”said Francis Scotland, director of global macro research at Brandywine Global, which manages $ 67 billion in assets. “But this phenomenon can exist for a long time because of this fundamental imbalance between saving and investing, or spending and saving.”

Even so, there are temporary factors at work. While the Fed has started cutting back on bond purchases, it still buys $ 60 billion in treasury bills a month. In total, the central bank has absorbed more than $ 3 trillion in treasury bills since February 2020, relieving public buyers. Meanwhile, many pension funds are almost fully funded for the first time since 2008, thanks to the stock rally, prompting them to buy fixed income securities to reduce their portfolio risk exposure.

Supply-demand imbalances could change next year as central banks around the world pull out of quantitative easing, which would cause bond yields to rise, according to JPMorgan Chase & Co. Global demand for bonds is expected to fall by $ 3.1 trillion next year, more than the expected $ 2.3 trillion drop in net supply, said JPMorgan strategist Nikolaos Panigirtzoglou.

But any increase in yields will likely be moderate. Goldman Sachs Group Inc. strategists led by Praveen Korapaty predict that 10-year real yields will only rise to minus 0.85% next year, leaving them in negative territory for a record third consecutive year.

What underlies the negative returns is the fact that investors have consistently considered one of the least aggressive rate hike campaigns in history.

Markets are currently only forecasting five 25 basis point rate hikes that would end with the Fed’s benchmark at around 1.5% by the end of 2024. In comparison, the central bank has raised the rate a total of 2.25 percentage points and 4.25 percentage points in the last two tightening cycles.

The Fed’s own dot-plot forecast in September projects that rates will rise to 1.75% by 2024 and only reach a neutral level at 2.5%. Fed officials could hit an even higher rate projection when they release new forecasts for the economy and the dot plot at Wednesday’s policy meeting.

Margie Patel, senior portfolio manager at Allspring Global Investments, doubts the Fed will hike rates to neutral.

“There is no incentive for the Fed to slam on breaks – and they know when they do that they cause recessions,” said Patel, whose company manages $ 587 billion in assets. “They’ve suppressed interest rates, they’re going to continue to suppress interest rates.”

The combination of low yields and high inflation this year has negatively impacted bond buyers, forcing them to look elsewhere for higher yields. Over the past decade, the Bloomberg U.S. Treasury Index has gained 2.3% per year, barely outpacing consumer price increases, even during times of relatively subdued inflation. Meanwhile, even as public debt has swelled since the pandemic, its interest charges fell to 2.5% of gross domestic product in the fiscal year that ended in September, from $ 2. 7% in 2019.

“We were not thrilled by the negative real rates,” said Christian Hoffmann, portfolio manager at Thornburg Investment Management. “It has become less of a free market. We don’t take a lot of duration risk at all. “



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