Fixed income investors can only hope the old saying “it’s often darkest before the dawn” applies to the bond market.
Wary bond investors may see their wishes come true in the coming months. After precipitously flirting with 5% just a weeks ago, 10-year Treasury yields have peeled back to around 4.52%. This indicates some market participants are, at the very least, nibbling at U.S. government debt.
Should that trend continue, it’d be supportive of Treasury-heavy aggregate bond exchange traded funds, including the Vanguard Total Bond Market ETF (BND ). The fund is one of the largest and least expensive fixed income ETFs, charging just 0.03% per year. BND is higher by nearly 1% over the past month. This indicates it’s benefiting from declining Treasury yields. Some experts believe more upside could be on the way for Treasurys.
Betting on Bond ETF BND
BND’s 10,702 holdings have an average duration of 6.3 years. While that’s not long duration, it’s long enough to imply some level of vulnerability to elevated Treasury yield. That’s due to the fact that two-thirds of the ETF’s roster is allocated to U.S. government debt.
That explains why funds such as BND have struggled this year. But some analysts believe some of the factors plaguing bonds in 2023 won’t repeat next year.
“Consider that the federal deficit this year rose largely based on lower revenues driven by factors that are unlikely to repeat,” noted Michael Zezas, global head of fixed income and thematic research for Morgan Stanley. “For example, Fed remittances zeroed out, and there’s about $85 billion of deferred collection of tax revenue due to natural disasters. Together with other factors, we think this year’s nearly 1% growth in deficits as a percentage of GDP will be followed next year by a decline of about 0.2%. Further downside is possible if a spending sequester kicks in, in April.”
As Zezas noted, there are other catalysts for bonds. These include the depletion of coronavirus stimulus funds and hiring close to being back to pre-pandemic levels. Those factors could keep federal and state government spending somewhat in check. That could potentially provide some ballast for assets such as BND.
“So bottom line, if you’re concerned about Treasury yields resuming their upward trend, look elsewhere for a catalyst. Consumption would be the most likely culprit but at the moment, our economists are still seeing downside there in the near term. This gives us confidence that the worst of U.S. government bond returns is probably behind us for this cycle,” concluded Zezas.
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