The Fed is still not the enemy. 1 For Wall Street Traders Eyeing Bonds

A forever enthusiast Jerome Powell made that crystal clear Wednesday — with a fresh caveat that rates Due to rising inflation, it may reach higher levels than expected.

After rallying briefly on hopes that the world’s most powerful central bank would soon proceed at a slow pace of policy tightening, bond yields resumed their familiar sell-off mode across the curve and traders took a stand. once again raised terminal-rate expectations.

While the odds suggest that Treasury investors will find life easier in 2023 after back-to-back losses, it may not be smooth sailing. Powell has put financiers on notice after insisting on going “some ways” before monetary policy becomes tight enough even after delivering another super-sized rate hike this week.

Among other things, it suggests that investors may be disappointed if they expect higher bond coupons to outweigh any price losses next year.

“They’re still looking at terminal rates as high as they need to tackle inflation,” KPMG chief economist Diane Swonk said on Bloomberg television. Will keep rates high for the long term.”

The Bloomberg US Treasury Index is already down more than 16% since the end of 2020 – set for the first consecutive annual loss in decades. Money-market traders now see the fed funds rate peaking at around 5.1% in May and not far below the end of 2023. Yet Powell stressed on Wednesday that the outlook ahead is unclear, suggesting that the risk of a Fed reversal is certainly more likely at the expense of economic growth too soon than possibly over-tightening.

A glimmer of hope for bond holders now is that the faster pace of hardening this year has boosted the regular income payments they receive, helping hedge against price-induced losses. Fixed half-yearly coupons on Treasuries now range up to around 4% on certain maturities. Bloomberg Intelligence says yields will have to rise much higher than at the beginning of this year before they can trigger a total return loss. Meanwhile a Bank of America Corp.’s analysis of 250 years of bond market data suggests that returns will be positive in 2023, if history is any guide.

Peter Slip, senior money manager at Seven Investment Management, said, “Next year will be a little better, but we’re not loading yet. Losses in some bond indexes have been terrible. Will we make all that back? No. What things? Could stabilize a bit? Yes. But if the Fed pivots too quickly, we could be in for a new cycle of tightening if inflation remains very high. That’s the biggest risk.”

The 10-year Treasury yield rose nearly 6 basis points to nearly 4.1% on Wednesday. After rising about 0.60 percentage points in 2021, the benchmark rate is up about 2.6 percentage points this year, according to an average of 46 strategists and economists surveyed by Bloomberg. It is projected to fall to 3.44% by the end of 2023.

A large drop in long-term yields could be caused if the US succumbs to an outright recession, as suggested by a slew of bond-market indicators. The majority of the curve is now inverted – meaning that short-term rates are higher than longer-term rates. Meanwhile, US manufacturing halted in October as orders contracted for the fourth time in five months, while an index of prices paid fell to its lowest level in more than two years.

“Our base case is a slight recession in 2023, but there is also the potential for a deeper recession given the risk of the Fed tightening,” said Mark Lindbloom, portfolio manager at Western Asset Management.

Under those scenarios, Lindbloom said Western is seeking a balance between owning high-quality corporate bonds that can deliver returns of at least 6.5% next year, as well as insurance against weak growth. Long working treasury.

“As growth slows and inflation subsides, bonds will outperform other asset classes in risk-adjusted terms,” ​​Lindbloom said.

This story has been published without modification in text from a wire agency feed.