This Asset Could Soon Be Poised For A Huge Comeback

This Asset Could Soon Be Poised For A Huge Comeback
Stéphane Renevier, CFA

11 months ago1 min

US Treasury bonds have historically been a great hedge against a slowdown in economic activity. That’s because when the economy slows down, central banks tend to cut interest rates to support demand. Since bond prices are inversely related to interest rates, they tend to rise in those periods. Plus, their high liquidity and low risk levels (they’re backed by the US government, after all) make them particularly trusty when times get tough.

This explains the tight relationship between the ISM manufacturing index (white line) – a reliable gauge of economic activity – and the yearly performance of benchmark 10-year Treasury bonds (blue line, inverted). When the ISM index is going down (and economic activity is slowing), you can see that bond prices are going up (but in this case the blue line is going down, given it’s an inverted scale).

Or at least, that’s how it usually worked, until 2021. That’s when persistently high inflation forced the Federal Reserve (the Fed) to hike interest rates despite a clear slide in the ISM index. The relationship broke down: the ISM fell, but rising interest rates caused losses in Treasury bonds too.

This might be about to change. The Fed’s aggressive hikes have started to bite the economy – it’s why the ISM is falling – and that’s likely to bring inflation further down too. With both inflation and growth under pressure, and interest rates at a level closer to the Fed’s target, there’s a fair chance that the Fed will – eventually – have to cut rates again. If that happens, Treasury bonds may be poised for an epic comeback given the amount of catching up they’d have to do.



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