Bond Balls at JPMorgan, Allianz. Double Down on Bet Gone Bad
(Bloomberg) — Convinced that a recession is imminent in the United States, some of the world’s most prominent money managers have loaded on government bonds this year in a bold bet that they will atone for the losses they made in 2022.
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This strategy is now unfavorable again, saddling them with sub-par returns and testing their resolve as the sell-off deepens week after week.
The past week has been particularly painful. The annual yield on US government bonds fell into the red as Treasury yields spun to a 15-year high, reflecting the view that interest rates could rise for years to come — and the economy will be able to sustain them.
Bob Michelle, one of the most outspoken bond bulls, was undeterred. JP Morgan Asset Management’s chief information officer for fixed income, which correctly predicted the slide to Treasury yields “all the way to zero” from 2% in 2019, says his strategy now is to buy every drop in bond prices.
The company’s flagship global bond opportunity fund is down 1.5% over the past month and has outperformed just 35% of its peers so far this year, compared to 83% over the past five years, according to data compiled by Bloomberg.
Others in the same camp — among them Allianz Global Investors, Abrdn Investments, Columbia Threadneedle Investments and DoubleLine Capital — think the economy is just beginning to absorb the impact of five percentage points from the Fed’s interest rate hike. This view is supported by the strongly inverted yield curve, which is a consistent harbinger of recession.
“We don’t think it’s any different this time,” Michelle said. “But from the first rate hike until a recession could take some time. We continue to see a growing list of indicators that fall at these levels only if the US economy is already in a recession or about to enter a recession.”
However, the US economy continues to defy recession. Growth is accelerating and new jobs are being created. Consumers are flexible. Even the US central bankers no longer expect a recession. Bank of America’s latest global survey finds that investors increasingly expect no recession at all within the next 18 months.
As they watch their recession, bond speculators are underperforming, and they are looking for ways to mitigate losses.
For those managing a pure bond fund, there are many leverages to bet on or against economic growth. A counter-growth bet might be to increase duration, a measure of sensitivity to interest rates, and to allocate away from riskier assets such as high-yield credit that are likely to experience losses from corporate defaults in a recession.
They can also hedge by making temporary adjustments to the term, even if it runs counter to their long-term views.
Despite being a bond bull, Columbia Threadneedle’s Gene Tanuzzo has been trimming term since July as the yield curve has become more inverted, shifting to shorter-dated Treasuries. The strategic income fund it helps manage is up 2.8% this year, outperforming 82% of competitors, according to data compiled by Bloomberg.
“The best days for bonds lie ahead,” said Tanuzu as the Fed nears the end of its campaign to raise interest rates.
By contrast, the fund managers at Abrdn and Allianz have over-term positions. DoubleLine also boosted its long-term bond allocation recently, but offset it with short-term corporate debt.
“We don’t think we’d be wrong,” said Mike Riddell, longtime portfolio manager at Allianz since mid-2022. “We’ve been staying too long. We don’t think all the monetary tightening will have any impact on growth.”
Historical patterns indicate that higher interest rates often depress economies. Former Federal Reserve Vice Chairman Alan Blinder studied 11 monetary policy tightenings from 1965 to 2022 and found that four of them ended in soft landings with more or less stable inflation, and the rest in hard landings.
But whether the returns will follow the economies, this time around, is another question. A major shift in the borrowing needs of the United States and other wealthy economies means that they are willing to allow deficit financing to fund aging populations and defense spending and deliver on promises to cut carbon emissions.
Faced with a flood of debt issues, investors will demand higher yields.
However, riding short treasury positions into 2023 wasn’t always the ticket to easy gains.
Virtus AlphaSimplex public mutual fund (ASFYX stock ticker) is down about 6% this year. While its short bond, long equity call appears well positioned to benefit from the current environment, a large portion of the drawdowns occurred during the banking crisis in the first quarter, according to Kathryn Kaminsky, chief research strategist and portfolio manager of AlphaSimplex Group. Her view is that prices will remain high, necessitating a short position.
AlphaSimplex sees 10-year US yield range up to 6%
“If inflation remains where we are now and rates are where we are now, there is no way that long-term cash flow — without a risk premium — can stay there,” Kaminsky said. “If rates don’t go down fast enough, the value of long-term fixed income has to go down. That’s what the market undervalues.”
For his part, JPMorgan’s Michel is confident that bond yields will fall once the Fed ends the tightening cycle, long before the first rate cut.
“Whether the US economy enters a recession or a soft landing, the bond market is surging after the latest rate hike,” he said. “The Fed may keep interest rates at these levels for some time, but growth and inflationary pressure continue to slow.”
— With assistance from Greg Ritchie and Isabelle Lee.
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