The U.S. Treasury market is off to its best new-year start in two decades as investors purchased government debt with expectations of the Federal Reserve slowing down its tightening efforts.
The benchmark 10-year yield tumbled 10 basis points, to 3.78 percent, on Jan. 3, the sharpest decline on the first trading session of the year since 2001. Yields continued heading lower in the middle of the holiday-shortened trading week, with the 10-year bond sliding nearly 9 basis points, to around 3.70 percent.
The rate-sensitive two-year yield also dropped nearly 4 basis points to around 3.7 percent, while the 30-year bond fell roughly 8 basis points to 3.81 percent. When bond prices rise, yields fall.
Many factors are currently driving the bond market’s momentum: investors on the hunt for attractive yields at a lower risk, a potential peak or end to the Fed’s tightening cycle later this year, and inflationary pressures subsiding.
Where Will Treasurys Head in 2023?
Following last year’s historical losses, bond returns are likely to rebound in 2023, says Dave Sekera, chief U.S. market strategist for Morningstar Research Services.Sekera forecasts that the fed funds rate will average 4.33 percent throughout 2023 and that the 10-year Treasury yield will average 3.5 percent.
In the second half of the year, investors might expand their duration in long-dated bonds.
Bryce Doty, senior vice president and senior portfolio manager at Sit Investment Associates, also agrees that bonds will be “more attractive” in 2023 while stocks struggle.
He anticipates that bonds will generate a decent income “with the potential for price appreciation as yields come off their peak,” adding that core bond funds could result in total returns as high as 8 percent this year.
Comparable to what happened more than 20 years ago, the financial markets believe that the U.S. central bank will start reducing the size and frequency of rate hikes. Fast forward to the present, and there’s also a growing chorus of economists and market analysts who think the Fed could slash interest rates as early as the middle of the year amid softening of the economy.
“All pivot doubters may need to recall that, just over a year ago, Fed members predicted fed funds would be less than 1 percent in November of this year!” Doty noted.
Will a Rebound Happen ‘for the Wrong Reasons’?
As a result of the selloff in 2022, these investment vehicles could “restore their roles as effective portfolio diversifiers,” Eric Leve, chief investment officer at investment firm Bailard, told The Epoch Times.“With 10-year Treasury yields currently at about 3.75 percent, they provide much richer starting income than they have been in more than 10-years (remember though much of 2020 these yields were between 0.50 percent and 1.0 percent),” he said. “With that, higher-yield bonds can also provide better diversification with stock returns than they have over the past year.”
According to Peter Toogood, CIO at Embark Group, government bonds are likely to increase this year but “for the wrong reasons.”
He recently told CNBC that shifting from quantitative easing to quantitative tightening in 2023 would send bond yields higher since governments will be issuing more debt since central banks are no longer purchasing.
“The inflation data are great. My main concern next year remains the same. I still think bond yields will shift higher for the wrong reasons ... I still think September this year was a nice warning about what can come if governments carry on spending,” he said.
In September 2022, the Bank of England hit the pause button on its tightening and temporarily bought long-dated bonds to “restore orderly market conditions.” This was in response to yields on UK government bonds (gilts) spiking, and the British pound cratering against the U.S. dollar as investors panicked following the government’s deficit-financed mini-budget.