By Davide Barbuscia
NEW YORK (Reuters) – Vanguard, the world’s second-largest asset manager, believes U.S. Treasuries are nearing the end of a painful slide even as prices fall to new multi-year lows, a senior portfolio manager at the firm told Reuters .
Yields on 10-year U.S. Treasuries, which move inversely to prices, hit their highest level since 2011 on Monday, continuing a trend that has put the bond in the midst of its worst year yet as the Federal Reserve makes massive rate hikes to to fight the inflation explosion. Markets broadly expect the central bank to raise interest rates by another 75 basis points on Wednesday, having already delivered 225 basis points of tightening this year.
Portfolio managers at Vanguard, however, believe bonds have already seen the worst of the downturn and the Fed is likely to pull back on its monetary policy tightening if growth starts to fall sharply. The Malvern, Pennsylvania-based firm manages approximately $7.3 trillion in assets.
“The more aggressive the Fed gets, the closer it gets us to a hard-landing scenario. And we know what happens in a hard-landing: there’s going to be a quick turnaround … and at that point clearly bonds start to perform again.” , said John Madziyire, senior portfolio manager and head of US Treasuries and TIPS at Vanguard Fixed Income Group.
He said Vanguard has recently been reducing exposure to lower-quality credit amid expectations of a more hawkish Fed.
“If you’re positioning for that, you obviously want to lean more defensively… And that by definition means you lean more towards Treasuries.”
Past rate hike cycles have seen yields peak before the Fed’s last two hikes, or three to six months before the end of the cycle, Madziyire said.
“As long as … you have your scenarios for potential tail risks and you’re willing to hold that position on that tail risk, you know that at some point you’re going to be right,” he said.
GRAPHIC: Fed funds and 10-year yields https://fingfx.thomsonreuters.com/gfx/mkt/lbpgnkxdjvq/Pasted%20image%201663602059968.png
Fed Chairman Jerome Powell said price pressures could ease without a sharp economic slowdown. He stressed, however, that the central bank will be relentless in its fight to eliminate inflation.
Expectations for the so-called terminal rate have shifted higher after US consumer price data showed inflation remained strong last month.
Fed funds futures traders expect rates to continue climbing to a high of around 4.4% next March, more than 200 basis points higher than the current benchmark overnight rate. That compared to 3.8% earlier this month.
Madziyire stressed that investors “must be willing to take a small loss” as timing the Fed’s pivot will be difficult.
“Market timing is almost impossible … but what you try to do is try to understand when you’re getting closer to the end and then position for that,” he said.
At the same time, the income earned from the higher yields can also help blunt losses if bond prices fall more than expected, he said.
“Even if the 10-year yields are 10 basis points higher than you would expect in the worst case, relative to the amount of yield you’re earning, you’ll make your money back because the yields are so attractive,” he said. .
(Reporting by Davide Barbuscia; Editing by Ira Iosebashvili and Nick Zieminski)