Analysis-As U.S. Treasuries tumble, some investors say turning point is near

By Davide Barbuscia

NEW YORK (Reuters) – Some investors believe Treasury yields are close to peaking, even as markets continue to price in more hawkishness from a Federal Reserve scrambling to tame the worst inflation in decades.

It’s a chorus heard more than once in 2022, as a steep Treasury sell-off swept investors betting markets would soon reverse while it battered stocks and fueled the dollar’s surge.

The bond slide has intensified in recent days as US Treasury yields – which move inversely with prices – hit their highest levels since the 2008 global financial crisis amid fears the Fed would have to hike rates more aggressively to lower consumer prices.

Meanwhile, fed funds futures late Thursday priced the US benchmark interest rate at 5% in May next year, versus bets this month that saw the rate at the time at 4.4%.

Still, some investors see the US Treasury sell-off nearing an end and believe the Fed will slow the pace of its rate hikes next year if inflation eases or the economy slips into recession.

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John Vail, chief global strategist at Nikko Asset Management, expects the Fed to hike rates by a total of 150 basis points over the next two months and then start cutting rates in the first half of next year.

“This forecast is dovish after January, which should bring a lot of relief to equity and bond markets,” he said.

Others believe higher yields will soon lure investors into Treasuries. Joachim Fels, managing director and global economic advisor at US bond giant PIMCO, recently wrote that markets have already priced in future rate hikes and “absolute yield levels look much more attractive than they have been for a long time”.

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Benchmark 10-year yields were at 4.23% late Thursday, while two-year yields were at 4.61%, presenting a more enticing picture for income investors compared to earlier in the year than those yields were 1.5% and 0.7%. respectively.

Among those arguing for a yield peak to come is Jeffrey Gundlach, chief executive of DoubleLine Capital, who tweeted on Thursday that there are “signs of yield hike exhaustion. Government bond yields could peak by the end of the year.”

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Fund managers are the most bullish on long-term bond yields since November 2008 in a recent survey by BofA Global Research, with 38% expecting lower long-term rates over the next 12 months.

Vanguard, the world’s second-largest wealth manager, told Reuters last month that US Treasuries are nearing the end of a painful decline.

Rising Treasury bulls are also pointing out that many yields are very close to where they think the Fed will see interest rates go next year.

Some investors were more reluctant to call a peak, citing the Fed’s single-minded focus on cutting consumer prices, which has proved far more persistent this year than many had anticipated.

“With inflation this high and rising, it would be a mistake to assume that central banks will move towards easing when something actually breaks,” BoFA strategists wrote. “Depending on where they are in their tightening cycle, they might not even take a break.”

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The Fed has hiked rates by 300 basis points so far this year. Fed fund futures traders are pricing in a 95 percent chance of a 75 basis point hike at the Nov. 2 central bank meeting, with Fed Chair Jerome Powell’s views on inflation and the economy seen as the next potential catalyst for yield moves will.

According to data from CME Group, futures traders are pricing in a 75% chance of another 75 basis point gain in December.

Zhiwei Ren, managing director and portfolio manager at Penn Mutual Asset Management, believes yields could fall if the economy enters a recession. However, he said ongoing labor shortages, disrupted supply chains and other long-term changes in the global economy are likely to keep inflation high.

“Just three months ago I thought 3.5% was a great level for a 10-year-old,” he said. “Now I think the 10-year bond could go to 5% or even higher in the next few years.”

(Reporting by Davide Barbuscia; Editing by Ira Iosebashvili and Gerry Doyle)

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