Higher-for-longer rates regime pressures US recession trades

SummaryU.S. bond investors revise recession betsEconomic resilience, fiscal concerns boost yieldsSome take more risks by shifting Treasuries allocationsBut new trades come with caveats due to macro uncertaintyNEW YORK, Aug 16 (Reuters) – Bond investors who had positioned portfolios defensively in anticipation of a U.S. recession are adjusting their strategies for a surprisingly resilient economy that will likely keep interest rates higher, longer than they had expected.A so-called soft-landing economic path – in which the Federal Reserve manages to curb inflation without causing output to contract – has gained more consensus in recent weeks, prompting some investors to take on more risk or reduce bets that safe-haven assets such as Treasuries would rally.Felipe Villarroel, a portfolio manager at TwentyFour Asset Management, which specializes in fixed income, said he was shifting some allocations from 10-year Treasuries to 10-year U.S. investment-grade corporate bonds. This reverses a build-up in positions in 10-year U.S. government bonds that started a year ago when yields were rising on the back of the Fed’s interest rate hikes.”The tail risk of a hard landing is being priced out, and that doesn’t mean we’re too bullish on the economy, but it does mean that the weighted average scenario has improved,” he said.For investors who had expected more economic strife, sticking to those calls has become increasingly difficult. Over the past year the unemployment rate has remained defiantly low, and growth has run consistently above trend.”It’s going to take longer for rates to rally,” said John Madziyire, senior portfolio manager and head of U.S. Treasuries and TIPS at Vanguard Fixed Income Group. “As a result, we have reduced those positions and expect them to happen way later than we expected previously.”Treasuries generally become more valuable, which means their yields decline, during periods of economic weakness, but long-term yields have spiked in recent weeks, with the benchmark 10-year hitting an almost 10-month high on Tuesday.In addition to pricing for more economic resilience, bond investors are also factoring in the Bank of Japan’s recent shift in its yield curve control policy, issues around U.S. debt sustainability as highlighted by Fitch’s U.S. downgrade, and the large funding requirements announced by the Treasury.”Recession or no recession, we think the probability of higher-for-longer interest rates is far greater than the likelihood of near-term cuts,” credit investment firm Oaktree Capital said in a recent note.Danielle Poli, managing director and co-portfolio manager of the Oaktree Diversified Income Fund, told Reuters the company shifted allocations, with a view of higher rates for longer, for instance by investing more in floating-rate debt. However, Oaktree is now more selective in leveraged finance, a sector in which borrowers are more susceptible to higher borrowing costs.Long-term concerns around the U.S. fiscal…

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