The yield on US 10-year Treasury bonds topped 2.8 percent on Tuesday, the highest point since 2018. The 10-year yield thus technically breaks the downward trend line that dominated the government bond market for the last four decades. “This is a harbinger of misery.”
“Such misery,” said Hendrik Tuch, head of fixed income at Aegon Asset Management, “always starts with a rise in interest rates”. Tuch said he is astonished by the speed at which US 10-year Treasury yields are now rising, and has yet to see them fall again.
Development seen crucial for market direction
The developments in the US bond markets are crucial for all other markets, Tuch said. He said investors should not forget that the bond markets are leading in the financial world. “That is where the price for borrowing money is set. If the Fed starts to tighten, and investors start a buyers’ strike because they anticipate higher interest rates, it will have an effect on all financial markets.”
40-year downtrend being tested
This year, US 10-year yields have already risen 150 basis points, a sharp increase, according to Water Leering, portfolio manager fixed income at InsingerGilissen Bankiers. But short-term interest rates are rising too: the US 2-year rate rose from almost 0.75 percent at the end of last year to 2.5 now.
“In Europe, you see the same picture of sharply rising interest rates along the yield curve. This is the result of rising inflation figures that turn out to be higher than expected. As a result, central banks are signalling that the loose monetary policy needs to be reversed and the market has priced in a lot of interest rate increases in a short amount of time,” he said.
Leering sees that premiums are also starting to rise within bond categories that require compensation for additional risks “Investors want higher interest rates for categories such as high yield, especially in emerging markets.” Emerging markets typically suffer from rising commodity prices, a tightening Fed, and a strengthening dollar.
Where does this end?
An important parameter for investors to get back into government bonds is the price of risky assets, according to Tuch. Only when this category sees sufficient yields will investors be interested in longer durations again. Until that happens, the Fed will not stop tightening either.
“I am afraid we need to see some bad economic data before investors regain interest in government bonds. These are now starting to trickle in,” said Tuch, who refers to the NFIB Small Business Optimism index.
This index, which gauges sentiment among US SMEs, fell in March for the third month in a row, to 93.2 points from 95.7 points in February, the lowest figure since April 2020. Employers are facing high inflation, they have to pay higher salaries and they cannot always pass everything on to consumers.
“We will not go long ourselves until the S&P 500 has fallen by about 10 to 15 percent. There are tough discussions going on within Aegon AM about asset allocation, but what we can all agree on is an overweight in short duration bonds like ABS and high yield,” Tuch said.
Technical analysis requires caution
Although the technical indicators show a trend reversal, both bond specialists are cautious about the predictive value of such analysis.
“Purely judging by the lines, there is a break in the trend, but that says very little,” Leering said. The reason why he does take these technical factors seriously is because many other investors do trade on these parameters. “Sometimes the momentum of such a trend is very strong.”
Tuch said he believes it is important not to ignore technical signals too much. “But you should also not place too much emphasis on them.” Other factors that are important are valuation, sentiment and macroeconomics.
‘Recession not our base case’
Leering, too, prefers to look at fundamental factors in the economy rather than the lines of technical analysts. “We have had a long period in which investor and central bank demand for bonds exceeded the supply of new bonds. There is now a lot of supply from governments, but on the demand side we are seeing that the big buyers, the central banks, are dropping out. They are scaling back their bond-buying programmes, so the balance between supply and demand is changing.”
“The curve has become very flat in the US,” Leering said. “A recession is not our base case scenario, but we see parties that take this into account. Indeed, it could be that some parts of the curve eventually invert, which in itself is not a convincing signal to get out of equities completely.”
This article was originally published on InvestmentOfficer.nl.
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