Bond investors in the U.S. are revising their strategies as the economy proves to be more resilient than expected, leading to higher interest rates for a longer period of time. The consensus among investors is that a soft-landing economic path, in which the Federal Reserve manages to control inflation without causing output to contract, is becoming more likely. This has prompted some investors to take on more risk or reduce their bets on safe-haven assets like Treasuries.
Felipe Villarroel, a portfolio manager at TwentyFour Asset Management, has shifted some allocations from 10-year Treasuries to 10-year U.S. investment-grade corporate bonds. This is a reversal of the previous strategy of investing in government bonds when yields were rising due to the Fed’s interest rate hikes. Villarroel believes that the risk of a hard landing is being priced out, leading to an improved weighted average scenario.
Other investors are also adjusting their positions. John Madziyire, senior portfolio manager at Vanguard Fixed Income Group, has reduced positions in Treasuries and expects rates to rally later than previously anticipated. Long-term yields have spiked in recent weeks, with the benchmark 10-year hitting a 10-month high on Tuesday.
In addition to economic resilience, bond investors are also factoring in the Bank of Japan’s shift in its yield curve control policy, concerns about U.S. debt sustainability highlighted by Fitch’s U.S. downgrade, and the large funding requirements announced by the Treasury.
However, there are caveats to the rising optimism. A re-acceleration in inflation could lead to higher rates than the market has priced in, potentially causing a sharper economic slowdown. The lag in the full impact of the Fed’s rate hikes is also unnerving investors.
To navigate the uncertainty, some investors are combining exposure to higher-yielding short-term bonds with long-term bonds in case of a downturn. Chip Hughey, managing director of Fixed Income at Truist Advisory Services, recommends a “barbell structure” that hedges short-term paper with long-term bonds in a more risk-off period.
Overall, while investors are adjusting their strategies in response to the resilient economy, there is still a lack of consensus on the future direction of interest rates and the economy.
How are bond investors in the U.S. adjusting their tactics in response to the unexpectedly robust economy and extended period of higher interest rates?
Bond investors in the U.S. are adjusting their tactics in response to the unexpectedly robust economy, resulting in an extended period of higher interest rates. It is now widely believed among investors that the Federal Reserve will achieve a smooth economic transition, keeping inflation in check without damaging economic output. As a result, many investors are increasing their risk exposure or decreasing their investments in safe-haven assets such as Treasuries. This shift in strategy reflects the growing confidence in the economy’s resilience and the potential for a soft landing scenario.
It’s important for bond investors to be adaptable in an ever-changing market.
The resilience of the economy and higher interest rates demand a shift in strategy for U.S. bond investors.