Stumbling rally clouds bond market outlook

US government bond investors hurting after the biggest annual decline in the history of the asset class are riding out yet another sell-off, as worries over persistent inflation cloud the prospects for an expected 2023 rebound.

Heavyweights such as Amundi, Vanguard and BlackRock turned bullish on bonds in recent weeks, on expectations that inflation has peaked and that a potential recession next year could push the Federal Reserve to end its most aggressive rate hiking cycle in decades.

Many investors have followed suit. December’s BofA Global Research survey showed fund managers were the most overweight bonds versus stocks in nearly 14 years.

But while bonds rebounded in October and November, prices have retreated over the last few weeks, as investors digested stronger-than-expected US economic data and as China reopened from Covid-19 restrictions, which some believe could add to price pressures in the new year.

Falling prices have pushed up yields, which move inversely. Benchmark 10-year Treasury yields have climbed over 40 basis points since mid-December to nearly 3.9%, the highest in over a month.

Two-year yields – which more closely reflect monetary policy expectations – hit an intra-day peak of 4.445% on Tuesday, their highest since November.

“The market seemed to have been getting ahead of itself expecting a pivot to occur from the Fed,” said Michael Reynolds, Vice President of Investment Strategy at Glenmede.

“It is coming to terms with the fact that the Fed is going to have to be tighter for longer, until they’re really sure that they’ve got inflation backundercontrol."