Bonds and Government Securities- The Pros & Cons

U.S. short and long-term interest rates fell to historically low levels as the 2020 global pandemic gripped markets. The tidal wave of central bank liquidity and a tsunami of government stimulus drove the short-term Fed Funds Rate to zero percent. Meanwhile, long-term rates dropped to levels where thirty-year conventional fixed-rate mortgages declined below 3%. Low rates and stimulus planted inflationary seeds that caused the economic condition to explode to the highest level since the 1980s.

In March 2022, the U.S. Fed’s FOMC began increasing short-term rates and launched a quantitative tightening program that reduced its balance sheet by allowing asset purchases to roll off at maturity. The Fed Funds Rate rose to a 5.25% - 5.50% high, where it remains on February 20, 2024. While the FOMC has not raised rates over the past months, it has not lowered them.

Longer-term rates followed the short-term rates thanks to quantitative tightening. Mortgage rates rose to over 8% at the highs and were hovering around 7% in late February 2024.

While rising interest rates tend to be bearish for stocks, the leading indices have rallied and are sitting near record highs. As stock prices have increased, the risk of a correction has risen, so many investors are putting more capital into bonds with guaranteed attractive returns.

Economic data favors lower rates and higher bonds over the coming months

• Interest rates fell to historic lows during the global pandemic.
• The Fed’s aggressive hawkish monetary policy pushed rates to levels that tamed inflationary pressures.
• Inflation has declined from the 2022 and 2023 highs.
• The Fed paused Fed Funds Rate hikes in late 2023.
• The market sentiment expects lower rates in 2024.

Geopolitical events could cause a flight to quality, pushing government debt securities higher

• The second anniversary of the war in Ukraine comes with no signs of ending any time soon.
• The conflict in the Middle East has made the region a geopolitical tinderbox with high odds of escalating hostilities.
• The U.S. bond market tends to be a haven of safety for investors during geopolitical turmoil.
• Higher interest rates attract capital flows from stocks to bonds.
  
  

The Fed is cautious- Inflation could increase- Traditional buyers could shun U.S. bonds

• The Fed is taking a wait-and-see approach to cutting interest rates. The latest CPI and PPI data validates the central bank’s cautiousness.
• Inflation has decreased, but the Fed’s 2% target remains elusive.
• Traditional buyers, China and Japan, have been wary of U.S. debt.

U.S. debt levels could cause downgrades and higher rates

• The U.S. debt at over $34 trillion is a warning sign that credit downgrades and higher rates could be on the horizon.
• At 5.375%, U.S. debt servicing costs over $1.8 trillion yearly.
• Even if U.S. spending and revenues balance, which is unlikely, the debt will grow at current interest rate levels, weighing on the leading economy’s creditworthiness.

A contentious election could cause volatility in the U.S. bond market

• Democrats appear likely to nominate President Biden for a second term despite his historically low approval ratings.
• Republicans are on a path to nominate former President Trump despite 91 pending felony counts.
• The polls show a politically divided U.S., with the candidates virtually tied.
• Since markets reflect the economic and political landscapes, a contentious election could roil markets, leading to significant volatility.

U.S. bonds face bullish and bearish factors in late February 2024. Technical support is at the October 2023 107-04 low, the lowest level since 2007. Resistance is at the December 2023 125-30 high on the U.S. government 30-year Treasury Bond futures. The TLT ETF moves higher and lower with the long bond futures. TLT’s support and resistance are $83.58 and $100.57 per share. At around $93 on February 20, the ETF that tracks the U.S. long bond futures is just above the middle of its trading range.

Thanks for reading, and stay tuned for the next edition of the Tradier Rundown!