Evening Brief – 01.03.24
U.S. Bonds in 2024: Room to Run
The US government bond market has had a rocky two years, but an impressive recovery in the final months of 2023 emboldens the case that the worst may be behind us.
Scouring analysis from several 2024 outlooks from research and investment management firms provides reason to believe that this year will restore much of the harm done to fixed income since the Federal Reserve began hiking interest rates in March 2022.
The Vanguard Total Bond Market ETF, an adequate proxy for the US bond market, has risen dramatically, although it is still about 10% below its levels in 2021. The message is that there is still more to run, assuming macro conditions remain favorable, with several technical indicators (rising moving averages, downtrending trendlines breached, among others) pointing to a sustained rally.
The path of inflation will remain a crucial issue for bond yields in 2024. Recent history suggests that price pressures will continue to ease and move closer to the Federal Reserve’s 2% objective.
“Adding in the further sharp slowdown in rent inflation still in the pipeline, it’s hard to see any credible reason why the annual inflation rate won’t also return to the 2% target over the coming months,” recently noted Andrew Hunter, deputy chief U.S. economist at Capital Economics, on CNBC.
The Federal Reserve appears to agree with the optimistic view. According to the central bank’s current forecast, inflation and its target rate will fall in the coming months.
“The rationale for adding duration now is underpinned by our belief that both the timing and valuations are favorable for investing in government bond markets,” explained M&G Investments, a London-based global investment manager, in its 2024 outlook.
Pimco notes that this is “Prime Time for Bonds.” In its November asset allocation report, analysts wrote: “We strongly favor fixed income in multi-asset portfolios. Given current valuations and an outlook for challenging economic growth and diminishing inflation, we believe bonds have rarely appeared more compelling than equities. We also look to maintain portfolio flexibility in light of macro and market risks.”
Pimco’s justification for preferring bonds over stocks is based on valuation. “Although not always a perfect indicator, the starting levels of bond yields or equity multiples historically have tended to signal future returns.”
The bulls’ projections for lower yields are based on lower anticipated inflation and interest rate cuts from the Federal Reserve. Fed funds futures are pricing in a 77% chance of the first interest rate cut at the March 20 FOMC meeting.