In the Monday, October 9 Barchart article, I wrote:
While the war in Israel and the potential for a widespread Middle East conflict could cause U.S. bonds to recover, the trend remains bearish. Critical technical support for TLT is at $80.51, the May 2004 low. Even the most aggressive bearish markets rarely move in straight lines, but the bond bear is approaching its fourth anniversary, with the trend picking up steam over the past weeks. The recent slide could mean a bounce is on the horizon. Fighting the bear is a contrarian approach that requires a prudent risk-reward approach and discipline to guard against getting financially mauled.
The U.S. 30-year Treasury Bond futures had declined to a 108-29 low on October 6. Since then, the bonds have made a lower low. Picking bottoms in any market is always a dangerous venture.
New lows in the long bond
The U.S. 30-year Treasury Bond futures reached a multi-year low in October 2023.
The long-term chart shows the decline to 107-04 was the lowest level since July 2007. The bond selling was due to the Fed’s hawkish monetary policy approach. Moreover, trend-following selling and liquidations by China and Japan added to the downdraft that took bonds to an over sixteen-year low in October 2023.
The Fed sends a signal as the bond market does its work
The U.S. Federal Reserve left the short-term Fed Funds Rate unchanged at the November 2 FOMC meeting. While the central bank reiterated its commitment to pushing inflation to its 2% target rate, the decline in the bond market made it possible for the second consecutive pause in rate hikes.
The Fed’s overall hawkish tone left the market with the impression that the odds of another 25-basis point hike to the 5.625% level before the end of 2023 is a 50-50 proposition. However, the inaction was more significant than the words, and bonds rallied after the early November meeting. The benchmark U.S. 30-year Treasury Bond futures were back above the 112 level on November 6.
The bottom line is the bond market did the tightening credit Fed’s job in October.
Fixed-income assets offer significant returns for patient investors
While selling dominated the bond market over the past weeks, interest rates rose to levels that attracted buyers. The yield on a ten-year treasury bond rose to over the 5% level on the highs. An investment in a ten-year treasury held to maturity yielded over a 60% return at the peak. With markets in flux over the current economic and geopolitical landscapes, fixed income returns at the highest levels in years have become more than attractive for conservative investors. Aside from the yield, the growing odds of a bond market recovery increase the potential for capital gains if the bond market rallies.
Mark-to-Market can cause indigestion
Over the past months, investment portfolios with a 60-40 split between stocks and bonds have declined on both fronts. The falling bond market has caused more than a bit of indigestion when investors receive monthly or quarterly statements. The decline in bonds caused market-to-market losses. However, held to maturity, government bonds return to par. Moreover, the drop created the opportunity to add more fixed income securities to portfolios at lower prices and higher yields. Short-term indigestion could become a medium-term bonus for portfolios if bonds recover.
Meanwhile, even if bonds continue to drop, holding them to maturity will offer the highest returns in years.
A changing world- Are the U.S. bond and currency markets havens of safety?
Government bonds and currencies depend on the full faith and credit of the countries that issue the debt and foreign exchange instruments.
The overriding question in late 2023 is if the faith and credit of the United States will remain the safest worldwide. The bearish case involves the staggering level of the U.S. national debt at the $33.7 trillion level. At 5.375%, short-term funding increases the obligation by more than $1.8 trillion annually. Another factor weighing on the U.S. is the bifurcation of the world’s nuclear powers. The rising odds of a BRICS currency that challenges the dollar’s role in the international financial system diminish the U.S. currency’s role in cross-border transactions and could weigh on the dollar’s value. China is the world’s second-leading economy and has been a significant owner of U.S. debt securities for decades. Chinese selling, or the lack of Chinese buying, could weigh on bonds, keeping interest rates higher for longer.
The bottom line for the dollar and U.S. government bonds is if the traditional safe harbor role holds over the coming years. If not, bonds could move lower, and the dollar’s influence on the world’s stage could decline. However, if the U.S. remains a global haven of safety, a significant rally could be on the horizon.
Markets tend to move to irrational, illogical, and unreasonable levels during bearish trends. Time will tell if U.S. bonds have reached a significant bottom in October 2023 or if more selling is on the horizon that will take them to lower lows. The current downside target is at the June 2007 104-31 low.
The latest Fed meeting suggests that bonds have more upside over the coming weeks as the trajectory of central bank rate hikes has slowed, and yields are at attractive investment levels in late 2023.
On the date of publication, Andrew Hecht did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.
