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The golden opportunity that analysts detect in US bonds

Date: September 24, 2023 Time: 20:54:37

Treasury bond yields in the United States experienced a state of flux in 2022, rising and falling based on contradictory economic news. This year, the 10-year Treasury yield has reached 4.3%, and some market observers expect it to reach 5%. But there are doubts that this could end up crystallizing. Some experts consider that the return on the reference asset in fixed income will end up falling, so it could be creating an attractive potential entry point for fixed income investors.

For Treasury yields to fall, at least one of three conditions would need to materialize: further evidence of a slowdown in the US labor market; a continued slowdown in inflation towards the Federal Reserve’s 2% objective, despite the fact that it has risen five tenths in annual terms to 3.7%; and continued weakness in mid-sized US regional banks. At the moment, we are seeing signs of all three, although this does not mean we cannot see short-term volatility in rates as economic data is released.

Borrowing costs have increased for many small and medium-sized businesses, and employers will ultimately have to decide whether it makes sense to continue adding to their workforce. As the excess savings of American consumers accumulated during the pandemic dissipates, the response may be increasingly negative. “Despite steady but slow job growth so far in 2023, jobs are starting to tighten and wage growth is stabilizing, which could portend a slowdown in consumer spending in the near term,” says Matthew Sheridan. manager of Alliance Bernstein and expert in fixed income strategies.

Inflation is also slowing, although not as quickly as policymakers would like. The personal consumption expenditures price index – the Federal Reserve’s preferred barometer of inflation – rose 0.2% in July for the second straight month, which has put some upward pressure on yields. Still, its annual rate of sale is the lowest it has been in more than two years. In addition, regional banks face liquidity pressures. The Fed’s Term Bank Financing Program, designed to shore up liquidity in the U.S. banking system, is set to expire in March 2024.

With bank liquidity a lingering concern and regional lenders seeking to offload private credit debt and leveraged loans from their balance sheets, regional banks may provide the Fed with one more risk to consider. This is especially true given their importance as lenders to small and medium-sized businesses.

The pressure of economic risks.

Treasury yields could also fall if other barometers of economic health deteriorate. The ISM Purchasing Managers’ Index – a reliable indicator of business confidence – was weaker than expected in August. Historically, there has been a relationship between PMI levels and Treasury yields, so this index will need to be watched.

The US budget deficit could also play a role. According to the Congressional Budget Office, the accumulated deficit for the period 2024-2033 is expected to exceed $20 trillion, or more than 6% of US GDP. Exceeding the 6% threshold is a historical rarity. If the cost of servicing debt increases, the US government will not have as much to spend on other programs, which could become an impediment to economic growth.

Of course, the Federal Reserve will have the final say. With the target federal funds rate at 5.25-5.5%, monetary policy is already in restrictive territory. “If economic growth is stable but inflation continues to slow, the Federal Reserve is likely to guide interest rates toward its neutral rate of 2.5%,” Sheridan says. “If the United States goes into recession, rates could go down even further,” she adds. In this sense, it would not be necessary for there to be a single catalyst for the economy to slow down. Any combination of factors could turn the tide. “In the current situation, we anticipate that the ten-year Treasury yield will be between 3.5% and 4% at the end of the year,” the AllianceBernstein expert specifies.

Attractive prospects for bonds

For fixed income investors, this could be a good entry point or an opportunity to extend duration. “Bond valuations are attractive and, despite the potential economic slowdown, corporate issuers are in a much better financial position than they were entering past downturns, with solid balances and high interest coverage ratios” , Sheridan says.

But with high yields, timing is critical. “In our view, investors should consider combining government debt with longer-term, high-yield credit that can benefit from lower rates in the future,” Morgan Stanley said in a recent report. “Such a diversified strategy can balance interest rate and credit risk, with high-yield bonds providing income and government securities that will offer the latter if market conditions become choppy,” concludes the analyst at the US fund manager.

Puck Henry
Puck Henry
Puck Henry is an editor for ePrimefeed covering all types of news.

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