US Bond Market Faces Uncertainty | Barry Eichengreen
TL/DR –
The last two years have seen a rapid decline in US Treasury bonds, making 2022 the worst year for bond investors since 1788, with prices set to fall again in 2023. However, with the interest rates on 10-year Treasuries now close to 5%, more than triple the levels of two years ago, many investors are returning to the market in anticipation of falling interest rates and recovering bond prices. Factors such as inflation, natural interest rates, geopolitical uncertainty, demographic changes, and changes in the supply of debt all contribute to the current state of the bond market, however, uncertainty continues to prevail.
US Treasury Bonds: Investor Concerns and Market Predictions
The last two years have seen a significant downturn for investors in US Treasury bonds. In fact, 2022 was the worst year for bond investors since 1788. Bond prices are predicted to fall once more in 2023, marking a historical first with three consecutive years of decline.
However, savvy investors are jumping back into the bond market. With 10-year Treasury yields nearing 5%, triple the levels of two years prior, yields are looking attractive. If the fundamental drivers remain stable, it’s likely that interest rates will decrease and bond prices will recover post-inflation scare.
Though inflationary fears are critical, multiple measures indicate inflation hovering around 3%, contradicting chronic high inflation warnings surpassing the Federal Reserve’s 2% target. Similarly, the “breakeven rate” on inflation-indexed Treasury securities points to expected inflation under 3% over the next decade.
Another aspect to consider is the natural rate of interest, orr*. Estimating r* has seen extensive debate, with consensus agreeing that r* determinants move slowly, balancing aggregate savings and investment. Savings rates largely rely on demographic factors such as working age population and the longevity of the retired.
However, the global savings glut suggests that it’s not just US savings rates that matter. Should Chinese GDP growth slow, leading to decreased Chinese saving, or should China rebalance from saving to consumption, it could impact the natural rate.
Geopolitical uncertainty also plays a significant role, typically favoring Treasuries as a safe haven in uncertain times. However, with current geopolitical tensions, yields are slightly up. If uncertainty persists or escalates, safe-haven flows are expected to return.
Debt supply is another factor. The federal government’s consistent deficits mean yields must rise for investors to absorb additional Treasury issuance. With the current political landscape, higher defense spending and resistance to tax increases could lead to even higher yields than currently expected.
Investing in bonds amidst this uncertainty is undoubtedly risky. In such scenarios, one should always proceed with caution and avoid relying solely on advice from a single source.
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