ROI-Darkest before dawn? Funds mull return to bonds: Mike Dolan

A grueling year of war, oil shocks and re-ignited ​inflation has hammered government bonds everywhere. Yet with higher US interest rates now a reality, some investors believe this is finally ​the moment to pounce on bonds offering yields not seen in decades. We've been here many ‌times ​before, of course, and speculative attempts to bet again on a turn in this six-year-long bear market in bonds have caused havoc for many punters.

For investors in Treasury exchange-traded funds (ETFs), it's been particularly painful, with the iShares US Treasury ETF down 3.6% year-to-date and on course for the second-worst annual loss in its 14-year history — second only to the oil and interest-rate shock following Russia's invasion of Ukraine in 2022. Long-term Group of Seven (G7) ‌government bonds, as measured by Bloomberg's catch-all index, have now almost halved in price since the pandemic lockdowns of 2020 — an average annual loss of about 9%.

But each historic milestone in rising debt yields tempts fixed-income managers to reconsider their exposure, and many are once again looking to extend the maturity and duration of their holdings. With yields on US and G7 10- to 30-year government bonds hitting their highest in decades this month, the latest wave of central bank rate hikes may curb any re-emergence of long-term inflation expectations. "We think that the worst of the big bond bear market ‌of 2026 may be behind us at this particular moment," RBC BlueBay's fixed-income chief investment officer, Mark Dowding, told Reuters on Tuesday.

In the wake of the first Federal Reserve rate hike in three years last week, he added that he was taking a more constructive view of ‌duration — essentially long-dated debt most sensitive to interest rate moves. Dowding's rationale was that the violent swing in Fed rate expectations in futures markets in recent months from a dovish, politically tinged view had hurt speculative players on the wrong side of the trade and pushed the pendulum too far in the other direction.

The market's pricing of as many as three more rate hikes through the middle of next year, the clearing out of loss-making speculative bets and what he saw as relatively benign inflation trends all pointed to a tentative return to battered bonds, Dowding said. That view was likely to apply equally to other central banks and G7 bond markets, Dowding said.

JUICY FRUIT? That macro take chimed with Goldman ⁠Sachs chief economist Jan ​Hatzius, who on Tuesday reckoned the Fed's surprisingly hawkish stance would still fall ⁠short of the more aggressive market pricing.

Even with one more hike in the arsenal this year, Hatzius wrote that Goldman still expected soft underlying inflation trends would see the Fed reverse those hikes by late 2027. "The repricing of monetary policy expectations explains most of the surge in government bond yields. Under our forecast that some of this repricing will ⁠reverse, our rates strategists see long-term yields also coming down modestly," the Goldman economist wrote.

And Apollo chief economist Torsten Slok also pointed out on Tuesday that nominal yields across the fixed-income universe were starting to look "juicy". "After a decade of reaching for yield in a zero-rate world, investors no longer have to take outsized risk ​to generate income," he wrote. "Even if yields rise further from here, current levels in high-quality fixed income are already attractive."

For mixed-asset portfolios, such yields still do not match the AI-driven equity gains on offer today. But with 10-year Treasury yields around 5% and earnings ⁠yields for the S&P 500 only a sliver above that, bonds now give equities a good run for their money. Even if the speculative bond bets from earlier in the year have been flushed out, the positioning of asset managers in bonds has not been this light in more than four years.

According to the latest Bank of America global funds survey released ⁠on ​the eve of this month's Fed hike, a net 48% of investors were underweight bonds, the most extreme reading since May 2022. The current mix of higher yields, light positioning and hopes for softer inflation is tempting many asset managers. But then the arguments for returning to bonds have been many and wrong for at least a couple of years.

Much will hinge on the most basic input to the macro view: precisely how strong the underlying growth trend is in the US and around the world. If growth is accelerating rather than slowing, then the hawkish take ⁠on the Fed and other central banks may not be so wide of the mark after all. That then spins into the scale of the AI buildout, not least with its corporate-debt implications, and the longevity of the energy inflation heat from two major wars ⁠still raging.

These are significant uncertainties for any major investment play, but the re-emerging bond ⁠bulls are relying more on the fact that yields are much higher and bear markets don't last forever. Whether bonds can start to perform without the stock market rolling over — with bonds traditionally at their best when equities are under pressure — is an altogether more difficult question.

(The opinions expressed here are those of Mike Dolan, a columnist for Reuters.) Enjoying this column? Check out Reuters Open Interest (ROI), your essential new source for global ‌financial commentary.

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(By Mike Dolan; Editing by Marguerita Choy)