Bank of America: US Treasury Bonds are in the "largest bear market in history", but will be the "best asset" in the first half of next year.

After the historic plunge in the US 30-year Treasury bond yield, will bonds become the "best asset" when the economic recession truly transforms into economic data by 2024?

On October 6th, Bank of America Global Research stated in a report that the drop in the US 30-year Treasury bond yield from its peak to its trough reached 50%, marking the "largest bond bear market in history."

According to the report, the bond sell-off has not deterred investors from entering the US Treasury market. EPFR data shows that in the week ending October 4th, bond funds saw outflows of $2.5 billion, but short-term US Treasury bonds saw inflows of $4.6 billion, marking the 34th consecutive week of inflows.

Michael Hartnett, a renowned strategist at Bank of America, pointed out in the report that once the economic recession reflected by the bond and stock markets truly "transforms into economic data," bonds will experience a significant rebound and become the best-performing asset class in the first half of 2024.

Hartnett has maintained a pessimistic view on risk assets this year, and he currently remains bearish on US stocks due to the possibility of an economic hard landing caused by rising interest rates. He stated that they are eagerly awaiting a capitulation sell-off and an economic recession or credit event to trigger favorable policy easing.

Since the Federal Reserve hinted that interest rates would have to remain at higher levels for a longer period than expected, bonds have been in turmoil. The yield on the 30-year Treasury bond once rose to 5.05%, and the yield on the 10-year Treasury bond exceeded 4.88%, both reaching their highest levels since 2007. However, due to investors heavily buying shorter-term Treasury bonds, the yield on the 2-year Treasury bond fell by 9 basis points.

As for the rapid rise in US bond yields, the reasons are still a mystery. "There is no convincing fundamental explanation so far," as commented by Daleep Singh, former executive at the New York Fed and current Chief Global Economist at PGIM Fixed Income.

"It is puzzling, and no fundamental explanation is convincing," Singh said.

"Sacrificing" US Stocks to Save US Bonds?

Bank of America pointed out in the report that the losses in long-term US Treasury bonds are now comparable to some of the most severe market crashes in US history. Data shows that since reaching its peak in March 2020, the prices of US Treasury bonds with maturities of over 110 years have fallen by 46%. The decline in 30-year US Treasury bonds has been even more severe, plummeting by 53%, approaching the 57% drop in US stocks during the financial crisis.

Barclays analyst Ajay Rajadhyaksha and his team stated that unless the stock market continues to decline and the attractiveness of fixed-income assets is restored, global bonds are destined to continue to fall. "New Fed Communications Agency" Nick Timiraos warns that the surge in long-term bond yields in the United States is destroying hopes of an economic soft landing. The sharp increase in borrowing costs could significantly slow economic growth and increase the risk of a financial market collapse, potentially weakening the rationale for the Fed to raise interest rates again this year.

However, not all of the bond market is being hit as hard as the 30-year Treasury bond. The report shows that because investors are buying shorter-term government bonds in large quantities, Hartnett writes, "There is no surrender here."

Media analysis suggests that the most reliable way to prevent a sharp rise in long-term bond yields is to eliminate the possibility of another rate hike by the Fed this year. If this does not work, the Fed can also indicate a willingness to keep quantitative tightening open.

Barclays' analyst team believes that the Fed is unlikely to relax its quantitative tightening plan, making it a net seller of US Treasuries. In addition, the increase in the US federal government's deficit has led to an increase in bond supply and a rise in term premiums.

Rajadhyaksha said that as foreign central banks slow down their net purchases, demand will weaken. As the largest foreign holder of US Treasuries, Japanese investors may favor domestic bonds as yields rise when the Bank of Japan adjusts its stance on loose monetary policy.

Barclays said all of this means that the fate of the bond market lies in the hands of the stock market. Analysts wrote that over the past three months, the S&P 500 index has fallen by about 5%, far from enough to trigger a rebound in fixed-income stocks.

Rajadhyaksha and his team said, "The scale of the bond sell-off is so large that, from a valuation perspective, the stock market can be said to be more expensive than a month ago. We believe that the ultimate way for bonds to stabilize is to further reduce the pricing of risk assets."