By Davide Barbuscia
NEW YORK (Reuters) – Vanguard, the world’s second-largest asset manager, believes US Treasuries are at the end of a painful decline even as prices plunge to new multi-year lows, a senior portfolio manager at the firm told Reuters.
Benchmark 10-year US Treasury yields, which are inversely proportional to prices, hit their highest level since 2011, continuing a trend that has brought bonds into the middle of their worst-ever year as the Federal Reserve pushes through massive rate hikes to combat rising inflation. Markets generally expect the central bank to raise interest rates by a further 75 basis points on Wednesday, after already delivering 225 basis points in tightening this year.
However, portfolio managers at Vanguard believe that Treasuries have already seen their worst declines and that the Fed is likely to reverse its monetary tightening if growth begins to slow sharply. The Malvern, Pennsylvania-based company manages approximately $7.3 trillion in assets.
“The more aggressive the Fed goes, the closer it gets us to a hard landing scenario. And we know what happens with a hard landing: there’s going to be a quick turnaround… and at that point, bonds are clearly starting to perform again, said John Madziyire, senior portfolio manager and head of US Treasuries and TIPS at Vanguard Fixed Income Group.
He said Vanguard has recently reduced exposure to lower-quality credit amid expectations of a more aggressive Fed.
“Obviously, if you position for that, you want to be tilted more defensively… And that by definition means leaning more towards Treasuries.”
Past rate hike cycles have shown yields peaked before the Fed’s last two hikes, or three to six months before the cycle ended, Madziyire said.
“As long as you have your scenarios of what the potential tail risk is and you’re willing to hold that position in that tail risk, you know you’re going to be right at some point,” he said.
CHART: Fed Funds and 10-Year Yields https://fingfx.thomsonreuters.com/gfx/mkt/lbpgnkxdjvq/Pasted%20image%201663602059968.png
Fed Chair Jerome Powell has said that price pressures can be eased without a sharp economic slowdown. However, he has also stressed that the central bank will be relentless in its fight to stamp out inflation.
Expectations for the so-called final rate have moved higher after US consumer price data showed inflation remained robust last month.
Fed futures traders expect yields to continue rising in March to a high of around 4.4%, more than 200 basis points higher than the current benchmark overnight interest rate. That was 3.8% earlier this month.
Madziyire stressed that investors “should be prepared to take a little loss” as it will be difficult to accurately time the Fed’s pivot.
“It’s almost impossible to time the market… but what you’re trying to do is try to figure out when you’re getting closer to the end and position yourself for that,” he said.
At the same time, earnings from higher yields could also help smooth out losses if bond prices fall further than expected, he said.
“Even if the 10-year yield goes 10 basis points higher than you might expect in the worst case scenario, relative to the amount of yield you get, you’ll earn your money back because the yields are so attractive,” he said. .
(Reporting by Davide Barbuscia; editing by Ira Iosebashvili and Nick Zieminski)