Longer US Treasury Bonds Give Investors Hope

It’s been a bad year for bonds and equities. Markets are dominated by the actions of major central banks and are struggling to adjust to the new reality of high and rising inflation.

I would keep the fixed income portion of my portfolio in short-term index-linked bonds and cash and near-cash for the better part of the year and wait until the U.S. Federal Reserve and other major central banks start raising interest rates and forcing bonds. I waited for Price cut.

More recently, we’ve been investing in longer-dated US Treasuries as yields offer better value.

Earlier, I took my stock portfolio out of equities On the technology-oriented Nasdaq It then reduced its exposure to growth sectors that were hit hard by the plunge.

The equities portion of the portfolio was a little less lossy by retaining a more diversified global share exposure. However, it was still affected by major shifts in mood and outlook and a significant decline in global equity markets. The entire FT portfolio on December 1st, he fell 11.4% for the full year.

2022 has reminded investors how dependent asset values ​​are on supportive central banks. The massive bull market of recent years, fueled by massive bond-buying programs by central banks, paid unprecedentedly insane prices to drive interest rates down to near zero.

I have never seen the advantage of buying bonds with no income in the hope that someone will buy them from you at a higher price. Central banks have bought many bonds far in excess of their repayments. This means that these banks now have huge unrealized losses. This will crystallize when bonds are sold in the market in a so-called quantitative tightening program or when bonds are repaid at maturity.

Central banks are also losing money by holding bonds. This is because the income received by the central bank will be less than the interest it has to pay on the reserves deposited by commercial banks. These reserves were inflated by the cost of bonds purchased by central banks and are now reflected in commercial bank deposits.

The Federal Reserve and European Central Bank have been slow to stop buying bonds and slow to raise interest rates to the levels needed to bring inflation down to their 2% target.

This prolongs the market misery, causing volatility over speculation about how high interest rates are and how long they will last. The recent Santa rally comes from many investors hoping the Fed will have to start cutting borrowing costs as early as next year as it approaches peak interest rates and responds to a slowing economy and recession. .

It is true that the money supply has expanded so much that it has reached a point where it cannot grow at all. At the same time, U.S. regulators are considering requiring commercial banks to hold more capital, making it more difficult for people and businesses to borrow. No further action should be taken. They should not overdo the strictness of their policies. The new year will require a slowdown followed by a pause in rate hikes.

The refusal of central banks in the developed world to take money and credit growth seriously magnified the scale of the error they made regarding inflation.

On the other hand, as Banks say, Russian President Vladimir Putin’s Invasion of Ukraine Inflation was well above target before the war began, leading to a significant rise in energy prices.

In China and Japan, despite being energy importers, inflation remains much lower than in the US and Europe. Certainly currencies vary in speed of circulation and frequency of use, which can offset changes in volume, but the places that have pushed currencies and credit the most appear to be showing higher rates of inflation now. all pay a high price for inflation errors.

The wisdom of the establishment teaches that central banks cannot fail. As many of them have unrealized losses on bonds that are many times their capital base, so too. Various central banks may report negative equity when bonds are paid back or sold at a loss.

The theory is that they can always generate money to pay their bills, unlike other companies that need to replenish their share capital and reserves or stop trading.

Various accounting treatments are used. The Bank of England receives cash for all losses from the Treasury, which always recapitalizes, so there is no problem.

The Federal Reserve has said it will report losses and create deferred assets on its balance sheet to offset them. It is said to represent future profits that are expected to be obtained one day. The European Central Bank will require the national central banks of the Eurosystem to absorb most of the losses. If necessary, these banks should be recapitalized by the government.

Eurozone officials are currently transmission protector Available. This will allow the ECB to return to bond purchases in countries facing declining bond prices and high interest rates compared to other member states. They argue that it will not be used to fund governments that refuse to accept EU or eurozone discipline when it comes to deficits and general economic policy.

These pressures may make the ECB more cautious than the US in raising rates too much and reluctant to sell many bonds at the cost of losses.

European interest rates remain unrealistically low for inflationary conditions. Policy will be guided more by favoring euro countries, trying to avoid large interest rate divergences across countries, and not wanting to aggravate a recession.

In contrast, the United States remains fixated on its hawkish rhetoric to bring inflation down quickly. A shift in US political priorities in the coming year, heightened concerns about income, jobs and activity, will very likely lead to a slowdown in the Fed’s economy.

As the old year draws to a close, weary investors are looking for better prospects for next year. US bonds now offer better value. I will be adding more to my portfolio as we approach a slowdown in US rate hikes and an upcoming moratorium.

The stock has fallen considerably, indicating lower growth and earnings going forward. January will see more debate about when governments will move from primarily fighting inflation to dealing with a recession that threatens to be too long and too deep.

Once we have a little more data on the extent and nature of recessions, it will be time to consider stock portfolios. Earnings forecasts are expected to be revised downwards as more sectors experience declining US housing starts and apparent problems with home sales.

Sir John Redwood is Chief Global Strategist at Charles Stanley. The FT Fund is a dummy portfolio intended to show investors how to use his wide range of ETFs to gain exposure to the global stock markets while keeping investment costs down. john.redwood@ft.com

https://www.ft.com/content/9d5b9126-e1ec-4e35-ace9-c25c1a39b3e3 Longer US Treasury Bonds Give Investors Hope

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