By | August 24, 2023

(Bloomberg) — Beaten U.S. Treasuries are proving irresistible to some investors even after Federal Reserve Chairman Jerome Powell said he is ready to raise interest rates again to curb inflation.

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Western Asset Management says bonds will outperform because of attractive interest rates, while JPMorgan Chase & Co. maintains its bullish bets on fixed income despite Powell’s warning at Jackson Hole Friday. Even fresh Fed hikes won’t produce bond losses steep enough to offset gains from the highest interest rates since 2007, the bulls argue.

“There may be considerable value in the bond market at current yields,” John Bellows, a fund manager at Western Asset in Pasadena, Calif., wrote in a client note. “Further declines in the rate of inflation will eventually allow the Fed to return real interest rates to more normal levels.”

In early US trading on Monday, Treasury yields were in broad retreat led by the 10-year, lower by more than three basis points on the day to around 4.20%.

The 10-year note’s yield hit a 16-year high last week as markets grew less optimistic about a potential Fed round of rate cuts. Powell, speaking at Jackson Hole, acknowledged that inflation had eased thanks to tighter monetary policy, but warned that the process “still has a long way to go.”

Treasuries gave investors a 1.3% loss in the first four weeks of August, heading for a fourth straight month of declines, according to a Bloomberg index.

Treasury yields at current levels suggest the worst of the rout is likely done, according to James Wilson, chief money officer at Jamieson Coote Bonds Pty. in Melbourne.

“We are very confident that we are near the top in returns,” he said. “Interest rates are at restrictive levels, but the lagged effects of monetary policy make it difficult to know when, and by how much, interest rates will trigger a slowdown in growth.”

JPMorgan is also bullish.

“With interest rates near their cycle highs, valuations somewhat cheap and next week’s data likely to show further easing in the labor market, we continue to hold tactical longs in 5-year Treasuries,” strategists including Jay Barry wrote in a note published on Friday.

Several other Wall Street banks are advising clients to add Treasuries, at least tactically, after last week’s move to higher yields. For example, Goldman Sachs strategists said position indicators suggest “that real money investors may find current real yield levels attractive enough and are likely to add duration,” a trend that could continue beyond this week.

Two Treasury auctions on Monday — a new two-year note at 11:30 a.m. New York time and a new five-year note at 1 p.m. — will gauge investors’ appetite for the higher yield levels. Based on pre-auction trading, the auctions were poised to deliver the highest returns since 2006 and 2007, respectively.

Bearish Funds

Not everyone sees government bonds as a bargain.

Hedge funds increased their bearish bets on Treasuries just days before the Jackson Hole symposium. They added net short positions across the curve from two-year futures to ultra-long securities, according to data from the Commodity Futures Trading Commission.

Some of these positions may be linked to what is known as the basis trade – a strategy that seeks to take advantage of differences in prices between cash government bonds and the corresponding futures.

What Bloomberg Strategists Say…

“Powell also did not go out of his way to rule out interest rate cuts. Ultimately, he signaled that the Fed can afford to proceed ‘cautious’ — a management style he shares with one of his most famous predecessors, Alan Greenspan.”

Anna Wong, US Chief Economist

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Investors “need a clearer course for interest rates,” said Kellie Wood, a fund manager at Schroders Plc in Sydney. “We’ve been cautious about adding rates here given that cuts continue to be priced out in a higher-for-longer environment, which would see the 5s and 10s underperform.”

While hedge funds increased their short positions, real-money investors are betting that Treasuries will rebound. Asset managers added net long positions in 10-year Treasury futures in the week to Aug. 22, CFTC data also showed.

“Investors have wanted a chance to lock in compelling returns since 2008,” Gautam Khanna, a money manager at Insight Investment in New York, said before the Jackson Hole event. “So they should seriously consider taking this opportunity to increase allocations to medium- and longer-dated US fixed assets.”

–With assistance from Matthew Burgess, James Hirai, Ye Xie and Joanna Ossinger.

(Adds strategy views in the 11th paragraph, auctions in the 12th paragraph, and updates the yield levels.)

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