(Bloomberg) — Investors who stock up on long-term bonds have history behind them.
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For decades, Treasuries maturing in 10 years or more have consistently outperformed short-term sectors immediately following the latest in a series of interest rate hikes by the Federal Reserve. On average, they returned 10% six months after the peak in the fed funds rate.
Of course, it is only in retrospect that one knows whether a rate increase is the last. But investors have embraced the idea that an expected quarter-point rise in the target range for the federal funds rate on July 26 will wrap up the epic streak that began in March 2022. And Bank of America Corp surveys . and JPMorgan Chase & Co. found that investors digesting price action increased their exposure to longer-dated bonds.
“We like the idea of extending and adding duration at this point in the cycle,” said Nisha Patel, managing director of SMA portfolio management at Parametric Portfolio Associates LLC. “Historically, in previous tightening cycles, yields have tended to fall” during the period between the last rate hike and the first rate cut, she said.
Bonds this week posted their biggest gains since March – when the failures of several regional banks sparked demand for refuge – after a report showed consumer prices rose at the slowest pace in two years . Swap contracts that as recently as last week attributed more than a 50% chance of another Fed rate hike after this month have repriced that to around 20% and added to bets on lower rates. rate next year.
The shift in sentiment hurt the dollar, which suffered its biggest weekly loss since November. While the European Central Bank and other major monetary authorities are expected to remain in tightening mode, there is likely more downside in store for the greenback, according to strategists at ING Bank NV
With respect to bonds, the most significant movements in yield have been in the short and intermediate maturities where expectations regarding Fed policy are expressed. The five-year rate fell nearly 35 basis points, compared to just 13 basis points for the 30-year.
But the greater sensitivity of long-term bond prices to a given change in yield means that investors can reap greater profits. On average, Treasuries maturing in 10 years or more have gained 10% in the six months following a peak in key Fed rates, compared to 6.5% for bonds maturing between five and seven years. and 3.7% for those maturing within three years, according to data compiled by Bloomberg. In 12 months, the longest bonds returned 13%, outpacing other sectors.
“There is finally revenue to be had in the fixed income market,” BlackRock Chairman Rob Kapito told analysts on Friday, calling the rise in yields a “remarkable change” and a “one-in-one opportunity.” generation”.
As an end-of-cycle theme, it has proven more reliable than betting on relative changes in yields such as the one that occurred this week as two- to five-year rates fell more than those at longer term, producing a steeper yield curve.
The difference between two- and 10-year yields increased in the six months after the Fed concluded a tightening cycle in December 2018, but narrowed after a cycle ended in 2006.
“Long duration at the end of the up cycle is a more consistent trade than the stiffener, which is more dependent on a harder landing outcome from the Fed,” wrote Bank of America strategists including Mark Cabana and Meghan Swiber, in a note.
A Bank of America investor survey conducted monthly since 2004 found that respondents had accumulated a record amount of interest rate risk against their benchmarks in June before shrinking a bit this month.
“I love the duration here,” said Eddy Vataru, fixed income manager at Osterweis Capital Management. Inflation, which fell to 3% last month, its 12th straight decline after peaking at 9.1% last year, could fall below 2%, he said.
To be sure, Fed policymakers remain on their toes. Their quarterly forecast for the policy rate published in June forecast two more increases this year. Fed Governor Christopher Waller said Thursday he was okay with that even after the latest inflation reading, as the labor market remains very robust.
Even if strong jobs prompt the Fed to continue to tighten beyond July, investors could pile into Treasuries because yields are high enough to provide a compelling hedge against a possible recession, said Michael Franzese, head of fixed income trading for the New York-based market. manufacturer MCAP LLC.
“You have a lot of investors now looking to make a bet and buy” if yields go up, he said. “We could see a flurry of new buying, as Treasuries are an asset that could start accumulating very well for investors when the Fed eventually cuts spending.”
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–With the assistance of Edward Bolingbroke.
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