Clobbered Fed rate cut bets wipe out even last year’s bond gains

INVESTORS wagering on an extension of last year’s global bond gains have been served a harsh reality check. 

Expectations of higher-for-longer US interest rates, bolstered by a hot inflation print this week, have helped wipe out the 4.2 per cent return on global sovereign debt from 2023. Bond investors eked out a gain last year after 24 months of losses amid bets on a Federal Reserve policy pivot, but bearishness is returning with full force as data continues to highlight the resilience of the US economy.

“The risk here is that the losses can extend,” said Gareth Berry, a strategist at Macquarie Group in Singapore. “A key danger is that excessive mark-to-market losses can lead to forced selling in bond markets.”

A Bloomberg gauge for government debt has declined 4.7 per cent since January, driven largely by investors now expecting under two Fed interest rate cuts this year – a significant backtrack from earlier bets of more than 150 basis points of easing starting March. Bonds have also come under pressure after the Bank of Japan raised its interest rate for the first time in 17 years, strengthening convictions of higher yields after the last anchor of negative rates lifted off. 

The selloff has room to run if Thursday’s (Apr 11) Treasury auction is any guide. A sale of 30-year US bonds received lackluster demand even as it offered one of the highest auction yields in the past decade. That’s a sign investors are concerned about dipping their toes back into the market after a the US inflation print this week sent yields surging across the curve.

Yields on benchmark 10-year US Treasuries eased two basis points to 4.57 per cent on Friday, but stayed close to the five-month high touched in the last session. 

Still, some are finding reasons for bonds to recoup their losses. UBS Global Wealth Management sees scope for Treasuries to rally when the Fed begins easing, while TwentyFour Asset Management says investors may also be looking to buy on dips.

“It is possible markets have a slight blip with prospects for rates cuts being priced out,” Felipe Villarroel, a portfolio manager at TwentyFour in London, wrote in a note. “Ultimately if this is just a delay as we believe it is, we would wager market participants will use a selloff as a buying opportunity thereby limiting the extent of a sell-off in spreads.” 

But sticky US inflation remains a key concern for bond investors from Sydney to Tokyo, underpinning views bond losses may extend. TD Securities’ Prashant Newnaha is among those predicting further declines.

“Our sense is that until Fed officials change their messaging putting risk markets on notice, this selloff in fixed income has more room to run,” said Newnaha. Yields climbing “towards 5 per cent or even higher in the US 10-year is not out of the question”. BLOOMBERG