As bonds emerge from a historic selloff, some investors expect better times in the U.S. fixed income market next year – as long as the Federal Reserve’s rate cuts play out as anticipated.
A fourth-quarter rally saved bonds from an unprecedented third straight annual loss in 2023, following the worst-ever decline a year earlier. The late year surge came after Treasuries hit their lowest level since 2007 in October.
The year-to-date total return for the Morningstar US Core Bond TR USD index, which tracks U.S. dollar-denominated securities with maturities greater than one year, was 5.47% as of this week, up from about minus 13% last year.
Fueling those gains were expectations that the Fed is likely finished with rate increases and will cut borrowing costs next year – a view that gained traction when policymakers unexpectedly penciled in 75 basis points of easing in their December economic projec ..
Falling rates are expected to guide Treasury yields lower and push up bond prices – an outcome that a broad swathe of investors are anticipating. The latest fund manager survey from BofA Global Research showed investors are holding their biggest overweight position in bonds since 2009.
Still, few believe the path to lower yields will be a smooth one. Some worry the over 100 basis point drop in Treasury yields since October already reflects expectations for rate cuts, leaving markets vulnerable to snap backs if the Fed doesn’t cut soon enough or fast enough.
The market has priced some 150 basis points in cuts next year, twice what policymakers have penciled in, futures tied to the Fed’s main policy rate show. Benchmark 10-year Treasury yields stood at 3.87% on Friday, after hitting their lowest level since July earlier this week.
“As long as the Fed doesn’t totally have this wrong, we should expect to see some rate cuts next year,” said Brandon Swensen, a senior portfolio manager on the BlueBay Fixed Income team at RBC Global Asset Management. However, “it could be a bumpy path.” ‘BONDS ARE BACK’
The late-year rebound in fixed income has bolstered the confidence of fund managers.
“Bonds are back,” Vanguard said in an outlook report published earlier this month.