Bonds are rallying so far this year, and there is reason to believe it can continue.
The yield in the 10-year note ticked down four basis points to 3.354% in Thursday’s trading on the heels of the Federal Reserve’s interest-rate hike on Wednesday. While an increase in rates would typically lift the yield of the 10-year, bond investors were encouraged by signs that the Fed is finally getting inflation under control. Bond yields move in the opposite direction as the price of bonds.
This year’s bond rally comes after they were hammered in 2022 by the Fed’s rapid pace of rate hikes, which moved the federal-funds rate from near-zero at the start of the year to 4.1% at the end of December. But so far this year, stock and bond investors alike have been more optimistic: the
Vanguard Total Bond Market Index
exchange-traded fund (BND) is up 4.1% this year while the
has gained 8.8%. While bonds and equities typically move opposite each other, the positive correlation between the asset classes is approaching levels last seen in the late 90s, according to J.P. Morgan. The move into positive territory could prove durable.
“Longer term, a more persistent fading of the so-called ‘Fed put’ or central bank backstop to equity markets could prolong the current phase of positive bond-equity correlation and make it appear more structural,” Nikolaos Panigirtzoglou, analyst at J.P. Morgan, wrote Thursday.
But in addition to the bond-equity correlation, Panigirtzoglou notes three parts of the market that are driving bond prices higher: retail investors, commercial banks, and foreign-exchange reserve managers.
So far this year, retail investors had net purchases of roughly $50 billion in bond funds, marking the highest monthly net inflow since September 2021 as yields have moved higher. At an annualized pace of $600 billion, bond fund inflows could more than eclipse the $200 billion net sold in 2022.
As of Jan. 18, U.S. banks have been net buyers of bonds to the tune of $35 billion. This comes after sales of $120 billion in the fourth quarter of 2022. J.P. Morgan analysts had predicted that commercial banks would purchase $250 billion of bonds this year, but if this pace of buying continues, that estimate will also be eclipsed.
While the U.S. dollar soared against other currencies in 2022 it has been weakening recently, leading foreign-exchange reserve managers to be buyers of bonds.
“Reserve managers tend to exhibit contrarian behavior, with inflows into specific currencies tending to strengthen after a depreciation and vice versa as they seek to rebalance holdings to target allocations,” Panigirtzoglou wrote.
With the dollar declining roughly 10% against other currencies since November, reserve managers have likely shifted to being buyers, which adds support to shorter-term securities.
Write to Carleton English at firstname.lastname@example.org