In an emailed statement, Eric Vanraes, portfolio manager of the Strategic Bond Opportunities Fund at Eric Sturdza Investments, noted that 2023 has seen a third consecutive year of negative performance for US Treasuries, casting doubt on the sustainability of this trend for a fourth year.
Initially, bonds were expected to rebound in 2023, but shifts in inflation expectations have postponed this recovery. The Federal Reserve’s strategy of high rates and quantitative tightening aims to control inflation and avoid a deep recession in 2025. If inflation concerns diminish, the bond market has reasons to be optimistic.
However, looking ahead to 2024, there are several key risks. The first concerns the volume of new issues by the US Treasury. The Treasury will have to significantly increase the volume of its new issues, and auctions have the potential to go badly, as happened recently with the 30-year bond. The main international investors in the primary market for Treasury bonds – China, the Middle East and above all Japan – are less and less interested – if at all – in these issues.
Markets believe that inflation, the second major risk, is receding – which is correct, and that it will probably disappear in 2024 – which is potentially wrong. As long as inflation is not 100% beaten, it is premature to consider that the problem is under control. If inflation does return, the Fed will raise rates – a level of 6% is not out of the question – which could take the markets by surprise.
A new liquidity crisis could turn into the biggest risk, similar to the one that we saw last March following the collapse of several US regional banks, and the failure of SVB. The US Treasuries market would benefit from this crisis. On the other hand, credit spreads could come under pressure.
Finally, while markets don’t consider geopolitical events a major risk yet, this has the potential to change in the New Year. It’s particularly surprising that the conflicts developing since February 2022 in Ukraine, and for the past few weeks in the Middle East, have had virtually no impact on markets to date.