A number of U.S. bond managers at firms in charge of trillions of dollars of assets are steering clear of long-term U.S. government bonds as they expect fiscal worries to spur periodic bouts of volatility.
Long-term U.S. Treasury yields, which move inversely to prices, briefly rose on inflationary and fiscal concerns in the aftermath of U.S. President Biden’s disastrous TV debate last month and after last weekend’s assassination attempt on former President Donald Trump, which increased expectations that Trump could regain the White House.
Bond investors sold long-term Treasuries as they fretted about Trump’s trade and economic policies that could, over time, boost inflation and U.S. debt levels. Trump’s team has said his pro-growth policies would bring down interest rates and shrink deficits. Many market participants believe deficits will keep deteriorating under a second Biden administration as well.
While yields subsequently declined on signs of a weakening economy, several bond managers at some of the country’s largest asset management companies expect long-term Treasuries to remain vulnerable to price drops as government deficits are expected to widen due to higher spending, including on debt interest payments.
Bond fund managers are cautious about adding exposure to long maturities, even though they remain bullish on the asset class because rate cuts by the Federal Reserve are expected to boost the prices of short– to medium-term government bonds, which more directly reflect changes in monetary policy.
“Interest rate volatility is likely to remain higher as a result of fiscal and other factors. … I think a lot of that is a function of this uncertainty around debt and deficit supply,” said Chitrang Purani, a fixed income portfolio manager at Capital Group, which manages over $2-trillion in assets.
Purani is “underweight” Treasury maturities of 10 years and longer in his portfolios, meaning he is buying less of those bonds, while he is offsetting that position with an overweight on intermediate maturities, he said in an interview.
Others in the market have similar views.
Sara Devereux, global head of fixed income at Vanguard, which manages over $9-trillion in assets, said she was bracing for “ongoing bouts” of rising fiscal debt premiums, referring to the extra compensation investors require for the risk of holding long-term debt that could lose value if issuance increases.
These episodes could be an opportunity to buy long-term bonds on the cheap, she said during a webinar this week. “But we really prefer the middle part of the yield curve, not going all the way out to the 30-year point where some of that term premium is just a little tricky right now,” she added.
Asset managers’ long positions in two-year Treasury futures notes hit an all-time high this month, Commodity Futures Trading Commission data showed. On the other hand, their bullish bets on 10-year note futures are about 10 per cent lower year on year.
Investment strategists at BlackRock, the world’s largest money manager with $10.65-trillion in assets, have also recently said they were bearish on long-dated Treasuries as investors will likely ask for more compensation to hold them because of increased supply.
The New York Fed’s gauge of the premium demanded by investors to hold longer-term government debt turned back positive on July 1, a few days after the Biden-Trump TV debate, for only the third time this year.
The Fed is largely expected to start cutting rates as soon as September as economic activity and inflation cool under higher borrowing costs. There is no end in sight for larger deficits, however.
The non-partisan Congressional Budget Office last month raised its cumulative deficit forecast for fiscal 2025-2034 to $22.083-trillion, up $2.067-trillion from its estimate in February. Federal debt held by the public could soar to nearly $48-trillion by 2034 from $26-trillion at the beginning of this year, it said.
The next quarterly U.S. Treasury refunding announcement is scheduled for July 29.
“There’s the economics, there’s the supply, and there’s the politics, and the supply and the politics are closely related,” said Robert Tipp, chief investment strategist and head of global bonds at PGIM Fixed Income, which manages over $800-billion in assets.
“It’s a good strategic point for fixed income as you’re past the rate hikes point of the cycle,” said Tipp. “But it’s not going to be a quick bull market with a big drop in long-term rates.”
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