THE tagline from Wall Street was that 2023 was the year of the bond. Instead, fund managers are coming to terms with one of the toughest years ever.

Lacy Hunt, Hoisington Investment Management’s 81-year-old chief economist who has been analysing markets, Federal Reserve policy and the economy for around a half-century, said it has been the hardest of his entire career.

At HSBC Holdings, renowned bond bull Steve Major said he was “wrong” to assume the US government’s growing supply of bonds did not matter. Earlier this month, Morgan Stanley finally joined Bank of America and moved to a neutral position on Treasuries.

“It’s been a very, very humbling year,” Hunt said. A 13 per cent year-to-date loss for the firm’s Wasatch-Hoisington US Treasury Fund came on top of 2022’s 34 per cent drop, data compiled by Bloomberg showed.

Treasuries declined on Monday (Oct 16) as concerns eased that the Israel-Hamas war would escalate to engulf other countries in the Middle East. The yield on 10-year US notes rose 5 basis points (bps) to 4.66 per cent. That is nearly 80 bps higher than where it started 2023.

Last year’s steep losses were easier to explain to clients – everyone knows bond prices suffer when inflation is high and central banks are driving up interest rates.

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The expectation in 2023 was that the US economy would crater under the weight of the sharpest run of hikes in decades – bringing gains for bonds on the expectation of policy loosening to come.

Instead, even as inflation slowed, jobs data and other key measures of the economy’s health remained strong, keeping the threat of faster price growth ever-present. Yields catapulted to highs not seen since 2007, putting the Treasury market on course for an unprecedented third year of annual losses.

And without the Federal Reserve in the market buying bonds to hold down borrowing costs, the US’s massive deficits – and the ballooning issuance needed to plug them – now matter in a way they did not before.

Hoisington’s Hunt and his colleagues constantly discussed whether to conduct a wholesale alteration of their favourable view on long-term debt, as their assumption that slowing inflation would curb yields failed to materialise. They did trim their duration earlier in the year, but not sufficiently.

“We thought that inflation would come down, and it did,” Hunt said. “In fact, there has been no decline that large in inflation that has not been involved with a recession in its immediate aftermath in the past. So the fact that gross domestic product is still rising is unprecedented.”

At the same time, it is the expectation that a contraction will eventually happen that is keeping Wall Street’s bruised bulls from retreating too far, as they try to manage their so-called constrained funds that can invest solely in the Treasury market.

“A hard landing is coming,” Hunt said.

Attractive levels

Bob Michele, chief investment officer for fixed income at JP Morgan Asset Management, trimmed the overweight position he had built in Treasuries when 10-year yields hit 4.3 per cent. They have risen by more than 50 bps since. While the current levels look attractive, the 40-year bond-market veteran is waiting for the dust to settle.

“We have to respect the market technicals and see where this can wash out,” said Michele, who earlier this year predicted yields could come down as low as 3 per cent across the curve by August. If yields on longer maturities go above 5.25 per cent and the employment market stays firm, then it is time to retreat for real, he said.

For a year touted by the likes of Vanguard Group and private equity giant KKR & Co as the point where Treasuries roar back – an “anchor in the storm”, Michele said at the time – the reality has been sobering. Since April, the 10-year Treasury yield has posted back-to-back monthly gains.

And while the bond market has clawed back some losses in the past week, it is fuelled by traders hunting the least-risky assets as the war between Israel and Hamas stokes fears of escalation. Behind the gains, the core uncertainty has not gone away, with the Fed signalling that the next change in interest rates could be a hike.

To be sure, a U-turn now would be costly: many long positions were opened when yields were at 3.75 per cent, according to data compiled by Jefferies International.

And even after the bond slump, there are still metrics that suggest investors can sit tight for longer. The so-called yield-to-duration ratio – a gauge of how much bond yields would need to climb to wipe out the value of future interest payments – is hovering around 89 bps.

Despite moving to shorter maturities, Mike Riddell, a portfolio manager at Allianz Global Investors UK, said he was still “very bullish (on) bonds”. For Aliki Rouffiac who manages multi-asset portfolios for Robeco, higher yields increase the risk of an economic hard landing, which is why she is using bonds to hedge against a possible prolonged pullback in stocks.

“It’s been a tricky three years,” said Chris Iggo, CIO for core investments at AXA Investment Managers. “The market has given the doubters more reasons to question the value of fixed income. Let me be bold though. Next year will be the year of the bond.” BLOOMBERG