Pain trade: rout ruins ‘year of the bond’

A relentless global bond rout is piling pain on to investors who loaded up on fixed-income assets this year as they spied the end of central banks’ cycle of interest rate rises.

The yield on 10-year US Treasuries climbed to around 5 per cent — a level not seen since before the global financial crisis — on Thursday, capping a rise from around 3.5 per cent at the start of the year that goes hand in hand with a sharp decline in prices.

The sell-off across the world’s bond markets resumed this week after a brief pause as investors flocked to safe assets following the outbreak of Israel’s war with Hamas.

It delivered the latest in a series of setbacks for investors who waded into fixed income in 2023 — dubbed “year of the bond” at the outset by Wall Street analysts — drawn by the highest yields in years and the expectation that the Federal Reserve and its central bank counterparts in Europe were close to finishing their campaigns of monetary tightening.

A survey of fund managers Bank of America published this week but undertaken earlier in October showed that bonds were by far investors’ favourite asset class relative to their historic weightings in portfolios.

Weekly data collected by the US Commodity Futures Trading Commission shows that asset managers had record long, or bullish, positions in 10-year Treasury futures in September, and record long positions in 30-year Treasury futures in October. 

“This has been painful for some market participants,” said Bob Michele, chief investment officer and global head of fixed income at JPMorgan Asset Management. “Everyone in the markets has to get their head around the fact that this may be another year of negative returns for bond funds.”  

Michele noted that after buying bonds earlier this year, his funds had cut some their holdings of longer-dated debt after the Fed’s September meeting at which the monetary policy committee, in their so-called “dot plot” survey, signalled they expected to keep interest rates higher for longer.

Performance in bonds funds this year hasn’t been as bad as 2022, but the “year of the bond” has so far failed to deliver. The Bloomberg global aggregate bond index — which tracks investment grade debt, like Treasuries and is the benchmark for many of the world’s largest passive bond funds — is down 3.6 per cent so far this year, after falling 16.3 per cent last year, its worst on record.

Among some of the largest actively managed bond funds, TCW’s Metropolitan West Total Return Bond fund is down nearly 4 per cent in the year to date, while Capital Group’s American Funds Bond Fund of America is down 3.7 per cent, according to Morningstar Direct.

Passively managed funds, particularly those concentrated in longer-dated maturities have been hit particularly hard. Data from TrackInsight showed that BlackRock’s iShares 20+ year Treasury ETF has been the best-selling fixed income ETF this year, attracting $17.9bn in the year to October 18 despite posting losses of 13 per cent over that time. The iShares 7-10 year Treasury ETF is down 4.7 per cent, according to Morningstar Direct.

Investors had been expecting a bigger economic slowdown on both sides of the Atlantic this year after the Fed lifted its target rate from close to zero at the start of 2022 to a current level of 5.25 to 5.5 per cent, the fastest pace of interest rate rises in a generation.

“Everyone knows the playbook — you buy duration on the last hike,” said Luke Kawa, an asset allocation strategist at UBS Asset Management. But, he said, “that playbook is being challenged.” 

But the Fed’s higher-for-longer narrative, and stronger-than-expected jobs, inflation and retail sales data over the past 10 days, have forced investors to change their expectations. 

“The economy keeps on percolating,” said Stan Shipley, an economist at Evercore. “There’s no sign yet of a recession — those odds keep decreasing.”

Mounting concerns over federal borrowing plans are also pushing yields higher, investors said, with worries over the federal government’s near-$2tn budget deficit exacerbated by Fitch Ratings’ decision in August to cut the US debt rating.  

“You can discern a change in the bond market from the Treasury announcement and the big step up in supply, which was the real problem for bond yields,” said Quentin Fitzsimmons, a senior portfolio manager at US asset manager T Rowe Price, referring to the planned increase in bond supply that the Treasury department announced in August.

Still, many asset managers argue that the pain is only temporary —- they are buy-and-hold investors who are more focused on the income they’re getting from bond coupons rather than the short-term price moves in these assets. 

“If you have been long duration, it is painful. We are long duration and it has been painful,” said Jack McIntyre, senior portfolio manager at Brandywine Global. 

“I think what is happening in the bond market is net positive for the next decade. We’re actually going to have income in the coming decade. Time is on your side, because of the income. It may be painful right now, but if you hold on, this will create opportunities.”