Amid what has been described as a “cruel summer for bond investors,” U.S. asset manager Vanguard is showing optimism toward longer-dated Treasuries. Their belief is based on the notion that the Federal Reserve has concluded its rate-hiking cycle and that the economy is likely to slow down in the coming year.
In their fixed income outlook, Vanguard, the world’s second-largest asset manager, explained that despite the challenging conditions bond investors have faced, long-term bonds remain an attractive option. This is primarily due to the anticipation of a shallow recession in the near future, driven by an economic slowdown. A slowdown, theoretically, could prompt the Fed to reduce borrowing costs, subsequently boosting the appeal of longer-dated bonds.
U.S. Treasury yields have seen a significant uptick in recent months, with the benchmark 10-year Treasury yields surpassing 5% for the first time since 2007. Vanguard notes that the relative advantage held by short-term government bonds can diminish rapidly, making it more advantageous for investors to secure higher rates over longer periods.
This outlook from Vanguard coincides with a decision by Bill Ackman, from Pershing Square Capital Management, to cover his bet against longer-term bonds. Ackman expressed concerns about the risks associated with shorting bonds at the current long-term rates.
While expectations of Fed interest rate cuts to stimulate the economy have been deferred multiple times this year, Vanguard predicts that such rate cuts are unlikely to occur until at least mid-2024. They also foresee that bond yields will not return to the historically low levels witnessed in the U.S. bond market.
Vanguard further contends that the Fed is nearing the end of its hiking cycle, which adds to the appeal of long-term bonds. This appeal is based on their high yields and the potential for capital appreciation in the event of an economic slowdown.
In summary, Vanguard believes that the fixed income landscape is entering a new era where bonds offer significantly more value in terms of total returns and as a portfolio stabilizer. Additionally, Vanguard expresses optimism regarding high-quality corporate bonds, as they believe these companies have maintained robust fundamentals by either avoiding borrowing or opting for short-term debt to mitigate the impact of higher funding costs.
This outlook underscores Vanguard’s confidence in the potential of long-term Treasuries and highly-rated corporate bonds in the evolving economic landscape.
