This time around, now that the threat of default is behind us, Treasuries are likely to resume their role as a haven in a storm.
This may have the air of inevitability, but it hasn’t been a sure thing.
The fissures that became visible in the Treasury bill and credit default swaps market in May were real, and many financial contingency plans included a small probability of a dire event: a U.S. default. Further downgrades of U.S. debt could be coming if the country’s politics become increasingly fractious and dysfunctional, and skepticism about the solidity of Treasuries could still dim their luster. Financial services companies like Goldman Sachs and MSCI included bear markets for Treasuries in their low-probability, high-risk scenarios for the latest crisis.
The Bond Outlook
For now, though, the prospects for the Treasury market look rather bright. Recall that on May 24, the yield on Treasury bills with early June maturation dates shot above 7 percent, a sign that traders demanded a hefty risk premium for buying them. Those yields dropped under 6 percent after Memorial Day, according to data from FactSet. Prices, which move in the opposite direction of yields, soared. And in the credit default market, the price for insuring Treasury debt has fallen to roughly one-seventh of its peak during this latest crisis.
Beyond the debt ceiling, other factors dominate the bond market. Foremost are the Federal Reserve’s long struggle to bring inflation under control by tightening monetary policy, the possibility of a recession and the pressure on regional banks resulting from rising interest rates.
Will the Fed raise short-term rates higher at its next meeting in June? Traders are now betting that it won’t. In addition, many indicators suggest that a recession is on the way.
Those factors make the argument for bonds — high-quality corporates as well Treasuries — quite compelling. Bond yields have already risen sharply over the last year, and those yields are a reasonably good predictor of bond market returns. Consider that if you hold a one-year Treasury bill for a full year, you can count on a return of more than 5 percent, which is a high threshold for riskier investments. Compared with stocks, short-term Treasuries are attractive.
The case is a bit less strong for longer-term bonds because their yields are a lower. In bond market jargon, the yield curve is inverted. That suggests that traders are expecting a recession, in which the Fed would be compelled to lower short-term interest rates to stimulate the economy.
Source: New York Times
