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Investors have piled into fixed income this year, lured by the promise of a bond comeback after a year of dismal returns. So far, the deal has failed to pay off handsomely.
Global bond markets fell 1% this quarter as persistently high inflation on both sides of the Atlantic forced major central banks to keep raising interest rates. Following a 3% gain in the first quarter, the setback means the asset class has so far failed to deliver on its promise of a strong rebound, while the Bloomberg All-World Aggregate Index, a broad gauge of global fixed assets, has fallen by a historic 16% last year. Income and the benchmark for many bond funds.
Investors are betting that inflation will fall as a recession looms, which is “on their eyeballs” for bonds, said Jim Bianco, president of Bianco Research. “It’s a painful bet. Over the past five or six weeks, many have found their performance has suffered,” he added.
Investors piled into bonds at the start of the year, with nearly $113 billion inflows into taxable bond funds in the first five months of 2023, compared with outflows of $107 billion a year earlier, according to Morningstar data.
There has been an influx of cash as major fund managers including JPMorgan, Pimco, Charles Schwab, Fidelity Investments and Amundi have announced a “bond return”.
Buyers want the highest yields in years. But many are also betting that the rate-hiking cycle by the Fed and other central banks, which was behind the fixed-income carnage in 2022, is coming to an end.
Earlier this spring, investors in the futures market were betting that the Fed would be forced to cut rates multiple times this year. But at the Fed meeting in June, the committee released its latest “dot plot” showing officials expect rates to rise to 5.6% this year, implying two more hikes.
The European Central Bank also warned at its June meeting that borrowing costs would rise further, while the Bank of England surprised markets this week by raising interest rates more than expected.
The moves are bad news for investors buying short-dated government bonds — bonds that are highly sensitive to the outlook for interest rates — in anticipation of an imminent peak in borrowing costs.
Two-year Treasury yields rose to their highest level in three months on Friday after Federal Reserve Chairman Jerome Powell testified before Congress that the central bank’s fight against inflation is not over.
“If you bought a lot of short-term rates at the beginning of the year, you might feel some pain because rates keep going higher,” said Jason England, global bond portfolio manager at Janus Henderson.
The iShares exchange-traded fund, which tracks one- to three-year maturities in the U.S. Treasury market, is down 0.6 percent so far in June, having also lost 0.6 percent in May.
While the decline looks modest compared to last year’s sell-off, some enthusiasm for fixed income appears to be waning.
Short-term government bond funds have seen $763 million worth of outflows in April and May, according to Morningstar. Flows into the broad class of taxable bond funds slowed slightly — $71 billion in the first quarter, compared with just $42 billion in April and May.
“If money flows in naturally, we don’t need slogans like ‘bonds come back’,” said a senior analyst at an asset management firm.
Some of that outflow may be due to the fact that Treasury bills — ultra-short-term, ultra-safe U.S. bonds with maturities ranging from a few days to a year — offered the best returns in decades, well above longer-dated Treasuries. – Riskier duration bonds.
“What we’re hearing anecdotally is that investors are willing to hold T-bills and government money market funds just to cut their yields, not short-term,” said Alex Obaza, a portfolio manager at T Rowe Price. fixed income.” . “We’ve seen some outflows from short-dated bond funds.”
Despite the underperformance, many fund managers are loosening bets on fixed income, arguing that higher yields offer margin for error, meaning holders can still earn positive returns even if prices dip slightly.
Greg Peters, co-chief investment officer for fixed income at PGIM, said the cushion provided by higher yields “is ultimately the story of bonds.”
“When rates are zero or negative and spreads are tight, that’s the worst environment because there’s no cushion. So I feel a lot more comfortable owning bonds today than I did in 2017.”