US debt returns to pre-pandemic levels although experts doubt this is the warning for an interest rate hike
After the unexpected profitability feast, although far from being comparable to that of the Stock Market, that the outbreak of the pandemic left for fixed income, the tables have changed significantly at the beginning of the year. So much so that the market has been feared that the unstoppable rally that US sovereign debt has enjoyed in recent decades has come to an end, with the collateral effects that this implies for all investment assets.
The cause is none other than the natural course of events that will follow the deep and historic economic crisis suffered in 2020: after the overwhelming measures of monetary and fiscal support launched by governments and central banks last year, it is time to economic reactivation, with the United States leading the Western economies.
And although the Fed insists that monetary stimulus is still very necessary to consolidate that recovery – and does not foresee rate hikes until at least 2024 – investors are already anticipating the next play, that of a price hike as a result of the economic rebound that makes the Federal Reserve’s intervention in the market less necessary. In short, less debt purchases by the Fed and market dynamics different from the one that has allowed the continued rise in bond prices.
This year, the yield on the 10-year US bond has gone almost vertiginously from 0.916% to 1.7%, levels clearly prior to the outbreak of the pandemic. Investors pay less for that asset and, consequently, it is necessary to offer more returns in return, which explains why the price of the bond moves in reverse of its performance. Such movement is clearly seen in the evolution of the Bloomberg Barclays U.S. index. Long Treasury Total Return Index, which has fallen 20% from its peak in March of last year and more than 10% in the last month and a half, a sharp decline for a fixed income asset and that for many is a sign of a bear market (see graph). Not surprisingly, it is the fastest correction in the last four decades.
US GDP Boost
This selling wave has arisen from the higher inflation expected for the next few months – in the face of the intense year-on-year rise in the price of oil – and has accelerated with the evident improvement in the growth prospects of the United States, after the approval of the stimulus Joe Biden’s prosecutor for $ 1.9 trillion. The Fed revised its GDP rise estimate for this year up to 6.5% this month from 4.2% in December, and the market consensus and US bond yield have moved accordingly.
The Fed does not plan to raise rates until 2024 but much of the market expects it sooner
But beyond the shock, almost worthy of marking a turning point, experts believe that the US bond, a benchmark for the fixed income market as a whole, has only returned to pre-pandemic levels, without implying necessarily the arrival to an environment of higher interest rates.
“The market, with this increase in profitability, is assuming that the pandemic is behind us and that everything will be growth. But we are not at the point of having to trade higher rates. They are still at a minimum, the context has not changed so much ”, points out Alberto Matellán, chief economist at Mapfre Inversión. The return of the US bond to prepandemic levels is, in his opinion, a sign of normalcy, even if it rises to 2%.
“I hope the pattern of returns remains the same, at least until there is evidence that the macroeconomic cycle is renewing,” adds Chriss Iggo, chief investment officer at Axa Investment Managers. For the moment, and although much of the market insists on believing otherwise, neither the Fed nor the ECB have given any sign of wanting to slow down in their stimulus. Much less the ECB, in view of the fact that the economic rebound after the pandemic will take longer to arrive in the euro zone than in the United States – where vaccination is progressing faster and restrictions on activity have been lower – and in the face of a inflation much further in Europe from the target of approaching 2%.
The rate hike
In Citi, in line with what investors advance, they do believe that the Fed will be surprised by inflation and will tackle a first rate hike at the end of 2022, compared to the central bank’s forecast of not raising them until 2024. They even add that three rate hikes in 2023 “would make sense.” In addition, the US bank already predicts the beginning of the reduction of debt purchases in the last quarter of this year.
Expectations for inflation and growth in the US have slowed the rally from the March lows and caused losses with a speed not seen in decades
At Goldman Sachs, they instead bend to the Fed’s forecasts, distancing themselves from the market, and do not expect a rise in interest rates in the US until early 2024, although they have revised their forecast for the yield of the US 10-year bond , which would reach 2% by the end of this year. They also foresee that level at the end of the year in Julius Baer, where they point out that the bund will touch 0.05% on that date, thus returning to positive territory for the first time in more than two and a half years.
Given the speed of the rise in yields, unexpected for investors and accelerated in good part by the increase in bearish positions, numerous firms have increased their profitability estimates for the benchmark bonds, although there are also nuances in the diagnosis on the meaning and scope of that movement.
At Bank of America they now forecast a treasury at 2.15% at the end of 2021, in view of the economic momentum of the United States. For this entity, 2020 marked the lowest point in inflation and interest rates and from now on, this decade will bring an increase in prices that will put an end to the bull market of sovereign bonds of the last 40 years.
The road to a recovery in CPI rates, which will inevitably rise this year even if only for the comparison with the unfortunate 2020, will in any case be gradual with a medium-term perspective and without this advance being a trigger for increases in types. Thus, the Fed has already declared its willingness to live with inflation rates above 2% for a long time without implying an immediate tightening of its monetary policy. In other words, a rise in interest rates.
This more flexible view of inflation by central banks therefore aims to be an element that will preserve the environment of low reference rates for longer. Both the Fed and the ECB are in fact insisting that the price hike expected in 2021 will be temporary, as could a rise in the treasury to levels of 2% or even higher. “If in the US we are going to see growth around 6% and inflation of 2.5% this year, a 2% bonus is reasonable,” says Alberto Matellán, who recalls that this rise in GDP is no longer it is forecast so strong in 2022. In addition, the enormous liquidity existing in the system will continue to play in favor of some containment in returns.
Meanwhile, a US bond close to 2% may be the opportunity to reactivate the role of sovereign debt as a safe haven, by offering more attractive returns. Its collapse to unprecedented lows came to question its classic role as a counterweight to portfolio risk. And, as it was before the pandemic, the active management of fixed income will once again be crucial to squeeze profitability. “Managing fixed income with falling rates is easy, returning to the prepandemic environment is reasonable,” adds Matellán.
This return to normalcy will also be a source of investment opportunities. ”The inexorable rise in inflation has stirred the waters in the fixed income markets. Bond prices have suffered, but not economic or credit fundamentals. With central banks firmly at the helm, we see this tidal wave as an opportunity in fixed income. We expect positive returns, clearly preferable to the assured loss of purchasing power in liquidity. Although also more modest than stocks, which we continue to recommend overweight, ”concludes Roberto Ruiz-Scholtes, strategy director at UBS Private Banking in Spain. A river uprooted, gain of fishermen.
