Getting down the yield curve

There is an old mountaineering saying: The mountain only belongs to you when you're back down. Every alpinist knows that most accidents happen on the way down, not on the way up. After a spectacular rise in recent months, US long-term yields have reached their highest levels in decades. Supposedly ultra-safe Treasury bonds are on track to lose money for the third year in a row, declining around 40% over that period. A record-breaking pace of rate hikes by the Fed to counter rapidly rising inflation and an unprecedented rate of government deficit (6.3% of GDP in fiscal 2023) has unsettled the markets and pushed long yields higher. The vexing question now is where long yields go from here: a rapid decline, a plateau, or yet another peak to climb?

Real-time money flow data indicate that many investors are betting on a rapid decline in yields: the pace of purchases of long-dated Treasury bonds is the highest in decades. Although long-term yields are most likely near their peak in the longer term, as the Fed is done hiking, there are numerous short-term risks lurking. One major headwind is the surprising resilience of the US consumer. Despite the Fed’s tightening of financial conditions, consumer strength and robust employment catapulted GDP growth in the third quarter of 2023 to an annualised rate of 4.9%. Lavish spending and tight labour markets usually bode ill for the prospect of inflation falling to 2% and for the Fed cutting rates soon. Another source of risk is the supply of US debt. The current rate of US government spending and debt issuance is unprecedented, and there is no sign of a future slowdown. All this rather points to at a plateau at high altitude.

We take a more cautious approach to coming down the yield mountain, with portfolio duration currently at 3.4. This sets us apart from most of our peers and has led to outstanding performance recently. Given our expectation of no further interest rate hikes, the next sensible move is to accumulate positions at the longer end of the curve. At the same time, we respect the upward momentum and remain cautious for the time being. Given our goal of achieving decent performance in both the short and long term, we deem current risks to outweigh the return prospects. In the mid-term, however, interest rates are set to fall, which will generate good performance for fixed-income investors. Climbing mountain summits is not easy, but with a proper planning and experience, a safe descent can be not only mentally satisfying but also, in the case of yield peaks, financially rewarding.