The “inflation mania” that has gripped debt markets this year has gone too far, according to some investors and analysts who say now is a good time to buy bonds at a discount.
A Bloomberg index of long-term US government bonds has fallen more than 18 percent this year, leaving it on track for its biggest decline on record since 1973.
The pullback in bond prices has pushed the 10-year Treasury yield, a benchmark for bond markets around the world, to almost 3 percent as investors position themselves for a rapid tightening of the monetary policy of the Federal Reserve and other central banks to deal with runaway inflation.
But fund managers and investment banks are increasingly wondering how much yields can rise as accelerating inflation, coupled with interest rate hikes designed to combat it, cause economic growth to slow, something that it generally enhances the attractiveness of safe assets such as government bonds.
“We see the current level of 10 years [US yields] as an attractive place [to buy the debt]”, Bank of America rate strategists said on Wednesday. “Concern about inflation has reached a level of mania or panic,” the bank said, citing “extreme” inflows into inflation-protected bonds, as well as an increase in Internet searches for “inflation.”
“Our forecasts are for inflation to peak this quarter and fall steadily through 2023. We believe this will reduce the level of panic around inflation and allow rates to fall,” Bank of America added.
The higher payouts now provided by holding bonds are already proving tempting for some fund managers.
“Gosh, they’re high enough now to buy,” said Edward Al-Hussainy, senior interest rate strategist at Columbia Threadneedle. “That’s what we’re doing”. He warned, however, that rates could go even higher.
“I don’t think you can be sure this is the cap until you get a signal from the Fed that they’ve gone over the line, or you get a correction in risk assets,” Al-Hussainy said.
Even some persistent bond bears are starting to ponder whether the sell-off is overdone. Dickie Hodges, who manages a $3.9 billion bond fund at Nomura Asset Management, said he had been “adding a little bit of exposure” to long-dated bonds as yields rose.
“I think it’s too early to call the top of the yields at this point,” Hodges said. “But central bankers know that raising interest rates substantially from these levels will push economies into recession. And I am convinced that inflation is going to resurface later this year, so long-term yields are starting to look attractive.”
Still, many investors are wary of drawing attention to falling bonds too soon. Barclays this week abandoned a recommendation issued earlier this month to buy 10-year Treasuries after yields continued to rise. The bank said the chances of the Fed “getting too tight” and pushing the US economy into a “hard landing” had diminished, and instead the central bank was likely to allow expectations of higher inflation to take hold.
A greater emphasis on reducing the Fed’s Treasury bond holdings, in addition to raising short-term interest rates, could also weigh more on long-term bonds, whose yields have been depressed by asset purchases. Fed board member Lael Brainard said earlier this month that the central bank would begin a “rapid” reduction in its balance sheet that could start as soon as its May meeting.
This possibility has left some fund managers reluctant to buy Treasuries, at least for now.
“If I could close my eyes and come back in six months, I think I’d be comfortably in the money buying here,” said James Athey, a bond fund manager at Abrdn. “But the potential journey to get there is so uncertain that it’s hard to find the right time. All it takes is a big bullish inflation surprise or a loose-lipped Fed speech and yields soar again.”