Wall Street Is Bearish on Treasuries in 2022. Maybe Too Bearish.

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Wall Street is bearish on the Treasury in 2022. The Federal Reserve recently pushed for a more rigid policy stance, and analysts predict the central bank could raise rates as soon as March. This signals a bad sign for prices, the opposite of yields, but global demand for high-yield Treasuries can limit or even prevent losses.

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If Treasury-market investors lose money in the coming year it would be a record-setting event. That’s because Treasuries haven’t posted losses for at least 43 consecutive calendar years, according to data from the ICE Index going back to 1978.

The Treasury market, as measured by an index tracking Treasuries maturing in a year or more, will almost certainly lose money in 2021, the first annual loss since 2013. As of December 30, the index was on pace to decline by 1.8%. The year. Poor performance has been driven by a jump in yields in response to a rebound in US economic growth from rising inflation and the pandemic slowdown, along with the Fed’s decision to launch its most ambitious easing program in modern history.

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The iShares US Treasury Bond ETF (ticker: GOVT) lost 2.3% for the year as of December 29, and the long-dated iShares 20+ Year Treasury Bond ETF (TLT) lost 5.6%.

At its December meeting, the Fed intensified its plans to tighten policy. It announced that it would reduce its bond purchases to double per month as originally planned, putting it on track to stop buying bonds entirely in March. More importantly, Fed officials predicted three hikes in the federal funds rate in 2022, well above the September rate hike forecast.

As a general rule, a tighter Fed policy means a higher return on treasuries. And Wall Street forecasts that the 10-year Treasury yield will rise to 2% by the end of 2022, according to data from Businesshala. On Thursday, the 10-year trade was taking place with a yield of 1.526%.

If there are two consecutive years of losses, it could indicate that Treasury yields have hit the multi-decade low that investors have been expecting since the 2008-09 financial crisis. Cumberland Advisors fixed-income chief John Musso said in a recent note that there is a bigger question about the “long-term” fall in US interest rates since 1981. “For the first time in my career at Cumberland, we now realize that in August 2020 one… less was done,” he wrote.

The yield on the 10-year note hit a low of 0.52% that month.

However, over the past decade many investors and market strategists have mistakenly made this call. And other trends still could spark a sea change in Treasury markets next year.

First, the bond-market supply will be low in 2022, as the US plans to borrow less in the coming months. The Treasury Department said in November that it expected to reduce the size of its bond sales. Analysts at ING say the drop in supply will be more than offset by a slowdown in the Fed’s bond-buying.

Second, some economists expect inflation to slow down next year, especially if the Omicron version of COVID-19 deals another blow to economic growth. Barclays strategists predict the Fed will halt rate hikes in late 2022 and early 2023, as they expect “deflationary pressure to prove more pronounced” than officials expected. Even if inflation doesn’t calm down, investors can put a lid on long-term yields based on the belief that the Fed will be effective in controlling consumer prices in the future.

There is “considerable uncertainty” surrounding that question, as Goldman Sachs said in mid-November about its rates outlook for 2022. So far, market prices haven’t reflected changes in inflation forecasts, even with US central bankers’ new hawkish stance on bond prices, which means investors remain optimistic about the next five years. Consumer prices will increase at a 2.9% annual pace in the U.S., and 2.3% over the next five years, up from 2.7% and 2.1%, respectively, around the time. Fed meeting in mid-December.

Despite inflationary risks, demand for treasuries among global institutions may remain strong, which have good reasons to buy next year. Corporate pensions, for example, may want to buy U.S. bonds to lock in their improved funding ratio after a roughly 30% year-over-year increase in the stock market.

Foreign buyers can also look to US markets for earnings, as well, as Fed Chair Jerome Powell observed at the central bank’s December press conference.

“Look at the global sovereign yield across the globe,” Powell said. “You Can Get a Much Higher Yield Than American Treasuries” [German] Dam and you can hedge it – Hedge the currency back to the Yen [or] Back in the euro – and still way ahead. So, in a way, it should come as no surprise that American sovereigns are in high demand in the world, where they are yielding far more than the Bund or [Japanese government bonds],

By no means is the Treasury a particularly good bet for returns in 2022. Even if Wall Street is correct and the 10-year climb is 2%, it would be below Fed officials’ 2022 average forecast for inflation, which was 2.2%. December. Inflation is currently running close to 7% based on the annual change in the US Consumer Price Index in November.

It is not unusual for investors to lose money in Treasuries on an inflation-adjusted basis. This has happened in seven of the past 20 years, as compared to the average of each year’s consumer price index with annual Treasury-market returns.

In short, investors shouldn’t expect much from their Treasury holdings, but they shouldn’t offload them either. Based on 40-year historical records, another year of losses would be unusual, and secured government bonds could be good protection against an unexpected economic downturn, possibly from the Omicron COVID-19 variant. Treasuries can also protect against Fed policy blunders that lead to an economic downturn—meaning that if they’re aggressive enough, Fed rate hikes could intensify for long-term Treasuries.

Write to Alexandra Scaggs at [email protected]

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