Bond investors who had positioned portfolios defensively in anticipation of a U.S. recession are adjusting their strategies for a surprisingly resilient economy that will likely keep interest rates higher, longer than they had expected.
A so-called soft-landing economic path – in which the Federal Reserve manages to curb inflation without causing output to contract – has gained more consensus in recent weeks, prompting some investors to take on more risk or reduce bets that safe-haven assets such as Treasuries would rally.
For investors who had expected more economic strife, sticking to those calls has become increasingly difficult. Over the past year the unemployment rate has remained defiantly low, and growth has run consistently above trend. In addition to pricing for more economic resilience, bond investors are also factoring in the Bank of Japan's recent shift in its yield curve control policy, issues around U.S. debt sustainability as highlighted by Fitch's U.S. downgrade, and the large funding requirements announced by the Treasury.
Long-term concerns around the U.S. fiscal position have recently boosted 30-year Treasury bond yields about 20 basis points, said Anthony Woodside, head of U.S. Fixed Income Strategy at LGIMA. "I think that the biggest mea culpa for me personally but also, I think, widely across the market, is getting it wrong that interest rates could be higher for longer and there could not be a recession, which would be positive for risk-on trades," said Stephen Dover, chief market strategist at Franklin Templeton Investment Solutions.
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