Stocks soared on Friday to their best day in more than a month. The Dow gained 700 points and the S&P 500 and Nasdaq rose by 2.3% and 2.6% respectively, as traders bet that a slowdown in wage growth could mean that inflation may finally be cooling off.
But the big turnaround story during the short first week of the year isn't just about equities, it's also about bonds.
What's happening: US Treasuries recorded their worst year in history in 2022, but investors are suddenly reversing course. They now appear quite optimistic about the bond market.
Last year's bond massacre came as the Fed raised short-term interest rates at the fastest speed in about four decades, lifting the Fed funds rate to its highest level in over a decade. Bonds are particularly sensitive to those increases — as rates are hiked, the price of existing bonds falls as investors prefer the new debt that will soon be issued with those higher interest payouts.
Now investors are betting that those rate increases are mostly over and that inflationary pressures are on a downswing.
Treasuries just notched their strongest start to a year since 2001, back when investors eagerly purchased government debt under the (correct) assumption that then-Fed chair Alan Greenspan was about to slash interest rates. This time around, investors are scooping up bonds as they anticipate the pace of Fed interest rate hikes will soon ease.
That's great news for Treasuries. Core bonds, or US investment grade debt, tend to perform well during Fed rate hike pauses. Since 1984, core bonds have been able to generate average 6-month and 1-year returns of 8% and 13%, respectively, after the Fed stopped raising rates, according to data from LPL Financial.
That anticipation could be seen at the end of last week. Treasuries tumbled following strong private jobs data earlier in the week but quickly rebounded when US payroll data showed that wage growth was weakening.
The gains are in sync with economists' positive outlooks for falling yields and rising bond prices in 2023.
The other side: The problem is that there's no guarantee that interest rates will actually come down, and investors could find themselves blindsided if they don't.
"The potential for rates to go high and stay higher for longer would hit bond markets hard, especially considering weaker economies would likely force governments to borrow more," said Chris Varrone, managing director at Strategas, a Baird Company.
Former Treasury Secretary Larry Summers issued a warning on Friday to bond investors who assume that inflation is easing and a new era of low interest rates is upon us.
"I suspect tumult" for bonds in 2023, Summers said on Bloomberg Television. "This is going to be remembered as a 'V' year when we recognized that we were headed into a different kind of financial era, with different kinds of interest-rate patterns."
Comments
Post a Comment