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The Tell: Treasury market returns are negative again. Why this time for bonds looks different than 2022.

Yearly returns in the Treasury market slipped into negative territory this week as the market sold off on signs that the Federal Reserve may need to keep rates high for a while to contain inflation.

While negative returns might stir bad memories of last year’s shocking losses for bonds, stocks and nearly everything else, investors holding Treasury debt issued at 2023’s higher yields might want to sit back and take stock.

“This is the top thing we hear,” said Ryan Murphy, director of fixed-income business development at Capital Group, of evaporating returns in what’s been a tough August. “You saw the worst bond market in 40 years last year. Investors, they are tired, and feel beaten up.”

Murphy’s message to clients is this: “In bonds, you earn the money over time.” And those dwindling bond returns since January? “Approach it with a deep breath, and know this is going to work out in the end.”

Capital Group’s laid-back style and lack of “a star CEO” earned it recognition by Institutional Investor in March as “a new bond leader” without a king, in large part because it attracted $100 billion in funds over the past five years, or twice the total of its peers.

Recent volatility in interest rates again zapped yearly gains in many bond funds, as Fed officials continued to warn that a roaring labor market and robust spending could keep inflation from receding to the central bank’s 2% annual target.

The spike in long-term bond yields makes older, lower-yielding securities look comparatively less attractive. That’s reflected in the yearly return on a key Bloomberg U.S. government bond and note index, which turned negative for the first time since March (see chart), when several regional banks failed, stoking fears of a broader banking crisis.

Returns on U.S. government bonds turn negative for the year.


However, a look back at August 2022 shows the 10-year Treasury yield starting around 2.6%, according to FactSet.

By contrast, Treasury bill yields BX:TMUBMUSD06M neared 5.5% on Thursday, or “north of anything we’ve seen over the past 15 years,” Murphy said. And for investors looking to lock in longer-term yields, the 10-year Treasury rate BX:TMUBMUSD10Y touched 4.307% on Thursday, its highest level since November 2007, according to Dow Jones Market Data.

See: How BlackRock’s Rick Rieder is steering his active fixed-income ETF as bond funds struggle

“It’s becoming more expensive for the government and companies to finance debt because of the rapid climb in rates,” Murphy said of the drag of higher long-term interest rates.

On the flip side, it’s also been one of the best stretches for lenders and bond investors in terms of getting paid to act as creditors since the 2007-2008 global financial crisis, but without a U.S. recession — or at least not yet.

What’s also different from last year is that the Fed already jacked up interest rates to a 22-year high of 5.25%-5.5% in July, and has signaled it’s likely nearly finished with hikes in this cycle.

Record cash on the sidelines

Murphy pointed to a mountain of cash on the sidelines, in the form of assets in money-market funds, as another potential stabilizer for markets.

Assets in money-market funds hit a record $5.57 trillion for the week ending Wednesday, according to data from the Investment Company Institute.

“What’s really interesting is that there’s been two bursts of investors going into money-market funds. There was a big shift right at the onset of COVID, and another burst over the past 12-18 months since the beginning of the rate-hiking cycle,” Murphy said.

Looking back to 2008, he pointed to a similar buildup in money-market assets, and a roughly $1.1 trillion wall of cash subsequently leaving the sector, as financial assets began to recover in the wake of the financial crisis.

“What we did see, while not all of it, was a healthy amount went back into fixed-income in the following years,” Murphy said.

Stocks closed lower Thursday and were headed for another week of losses, with the Dow Jones Industrial Average DJIA 2.3% lower on the week so far, the S&P 500 index SPX down 2.1% and the Nasdaq Composite Index off 2.4%, according to FactSet.

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