Bonds’ rally after a tough year shows the strength of rising rates

Bloomberg — Wall Street is finding reason to continue investing in the bond market, even as the Federal Reserve is still far from declaring victory in its war on inflation.

Selling bonds, which means recording losses for investors during the first ten months of the year, It also ended an era of lower interest payments on Treasury bonds, sending yields to their highest level in more than a decade.

Those coupon payments, now in excess of 4% on recently issued 2- and 10-year notes, are now large enough to attract buyers and are seen as providing a buffer against future price declines. The economy’s resistance also reinforces the arguments: If the Fed is forced to tighten monetary policy to the point that it causes a recession, Treasuries are likely to rally as investors look for a place to hide.

“The coupon is becoming an even more important source of returns,” says Jack McIntyre, portfolio manager at Brandywine Global Investment Management. “Bond mathematics has become a tailwind.”

The bond market gained support on Wednesday when Federal Reserve Chairman Jerome Powell indicated that the central bank is likely to ease the pace of interest rate hikes at its scheduled December 13-14 meeting.

The comments added fuel to a rally that began in early November after consumer price inflation slowed. This sent the Bloomberg Treasury Index up more than 2% for the month, the first gain since July and the largest since March 2020, when the onset of the Covid-19 pandemic in the United States sparked a rush into safer assets.

Powell’s moderation in his hawkish tone spurred demand from investors looking to lock in current yield levels or close short bets against bonds.

Continued buying pushed the two-year Treasury yield from 4.55% on Wednesday to 4.18% early on Friday, before yields rose on the back of a stronger-than-expected jobs report for November. Off the curve, 5-year and 10-year yields continued to decline and remained at their lowest levels since September.

The rally in Treasury yields largely disappeared after the jobs report

McIntyre warned that the market’s volatility may not end, as signs of persistently high inflation could cap the size of future hikes or send yields higher again.

“While inflation is coming down, it still has a long way to go,” he said. “We don’t know when and if we need a major recession to make that happen.”

But Friday’s reaction to the still brisk growth in jobs and wages shows the underlying support the market has been getting from rising prices over the past year. This has led to coupon payments on bonds auctioned by the Treasury Department rising steadily.

“The upward trend in rates is not going away overnight,” says Kathryn Kaminsky, chief research strategist and portfolio manager at AlphaSimplex Group, whose public investment fund is net fixed income and has risen more than 34% this year. But we have seen that volatility has increased steadily throughout the year. So the relative strength of the bearish signal relative to the volatility is getting less strong.”

In addition, there were additional signs of weaker growth and easing of inflationary pressures. The Fed’s target measure of consumer prices rose at a slower-than-expected pace in October, according to a report released Thursday.

Investors will be watching data on the services economy, producer prices and inflation expectations next week for more indications of how the rate hike will affect the economy. Fed policymakers will not speak before their mid-December meeting, when the central bank will update its economic forecasts.

Expectations that tightening monetary policy will slow the economy led to long-term bonds posting their biggest gains since early November, with 30-year yields falling again on Friday. sBut short-term stocks have also rallied over the past month, highlighting the appeal of higher coupon payments for investors that seek to obtain a return to maturity.

Scott Solomon, associate portfolio manager at T.