Bets on the Year of the Bond Are Still on Even as Losses Return

(Bloomberg) — It’s way too soon to abandon hopes for a strong bond-market rebound in 2023, which seemed like a sure thing as recently as a month ago.

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But even if plowing back into Treasuries proves to be a winning trade, sticking with it won’t be for the faint of heart.

A surge in job growth, rising consumer spending and faster-than-expected inflation have sent bond prices sliding again by convincing traders that the Federal Reserve will keep pushing up interest rates and hold them there for longer than had been anticipated. The drop has wiped out the strong gains from January, when markets were still betting that the central bank was nearly done tightening monetary policy and would be cutting rates by year’s end.

“This has been a tough month for the bond market,” said George Goncalves, head of US macro strategy at MUFG Securities Americas Inc., on Bloomberg television Friday. “A lot is sort of priced in at this time, but at the same time if we don’t see a move lower in March, April, May” inflation readings “then we have a bigger problem on our hands for the market.”

On Friday, the bond market was hit by a renewed bout of selling after the Fed’s favored inflation gauge — the personal consumption expenditure index — unexpectedly accelerated in January by rising 5.4% from a year earlier. That pushed up yields across the board, driving those on two-year Treasuries to as much as 4.84%, the highest since 2007. A broad gauge of the Treasury market has lost some 2.6% in February, leaving the securities now down slightly in 2023 after the first back-to-back annual losses since at least the early 1970s.

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The inflation reading followed a steady drumbeat of strong economic figures that have galvanized speculation that the Fed still has a ways to go before winning its fight against inflation. Swaps traders are now pricing in quarter-point rate hikes at the March, May and June meetings, which would push the target range for its key benchmark to 5.25%-5.5%.

Yet, even with the more aggressive path, investors still see reasons for some optimism. Most of the losses triggered by the central bank’s tightening are still likely in the past, given that it has already pushed its rate from near zero last March to 4.5%-4.75% currently. Higher interest payments on Treasuries are also softening the blow.

“It seems like the pendulum has swung the other way in the bond market – with us starting to price in a very aggressive path of rate hikes,” said Subadra Rajappa, head of US rates strategy at Societe Generale SA, who sees the nearly 4% yield on 10-year Treasuries as a buying opportunity. “It’s very tricky now. It’s still too hard with the data we have to be clear on the trajectory for the Fed going forward.”

The market may get a temporary reprieve from the selloff in the coming week because there’s no major data releases. The Treasury Department has also wrapped up its note auctions until March 7, while month-end portfolio rebalancing may spur buying from fund managers.

RJ Gallo, senior portfolio manager at Federated Hermes, said the likelihood of a more aggressive tack by the Fed has increased the odds of a US recession, which would cause bond prices to jump in the years ahead. Moreover, present yields are attractive, he said in a Bloomberg television interview, adding the firm is overweight Treasuries in their total return bond fund.

“In January there was a little bit too much enthusiasm in the bond market,” Gallo said. But, with yields as high as they are, “you now have income to support total return.”

What to Watch

• Economic calendar

  • Feb. 27: Durable goods orders; pending home sales; Dallas Fed manufacturing activity

  • Feb. 28: Advance good trade balance; wholesale/retail inventories; FHFA house price index; S&P CoreLogic CS home price indexes; MNI Chicago PMI; Richmond Fed manufacturing index; Conference Board consumer confidence; Richmond Fed business conditions; Dallas Fed services activity

  • March 1: MBA mortgage applications; S&P Global US manufacturing; construction spending; ISM manufacturing; Ward vehicle sales

  • March 2: Nonfarm productivity; unit labor costs; jobless claims

  • March 3: S&P Global US services PMI; ISM services

• Fed calendar

  • Feb. 27: Fed Governor Philip Jefferson

  • Feb. 28: Chicago Fed President Austan Goolsbee

  • March 2: Fed Governor Chris Waller

  • March 3: Dallas Fed President Lorie Logan; Atlanta Fed President Raphael Bostic; Fed Governor Michelle Bowman

• Auction calendar:

  • Feb. 27: 13-, 26-week bills

  • March 1: 17-week bills

  • March 2: 4-, 8-week bills

–With assistance from Elizabeth Stanton.

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