Rally Up! A Bond's-Eye View
We have recently discussed that US Treasuries are the top-performing major sovereign debt this year, returning 5.85%, at time of writing. This rally has been fuelled by the growing expectation that the Fed will restart their easing cycle at tonight’s FOMC meeting. This prospect has reversed a previously bearish outlook on US debt, leading to a significant drop in the extra yield Treasuries offer over other global bonds, which now stands at a three-year low. In contrast, bonds in other countries have underperformed due to specific local issues, such as fiscal deficits in France and a hawkish central bank in Japan. This rally is expected to continue, as the Fed cuts rates in response to a weakening economy, a scenario that has historically favoured US government debt.
Meanwhile, in a potentially disruptive development, Donald Trump's appointee to the Fed’s Board of Governors, Stephen Miran, has openly invoked a long-dormant "third mandate" from the Fed's charter: the pursuit of "moderate long-term interest rates." This has raised alarms, with many viewing it as a clear indication that the administration intends to politicise the central bank's actions and influence long-term bond yields to serve its own goals, such as stimulating the housing market and reducing the cost of servicing the national debt.
The primary concern is that politicising the central bank's actions can lead to higher inflation, as a non-independent Fed may face pressure to keep interest rates artificially low to serve short-term economic or electoral goals, rather than to maintain price stability. A loss of credibility would not only undermine the Fed's ability to manage the economy effectively but could also lead to greater volatility in financial markets, as investors lose confidence in its commitment to data-driven policy. While historical precedent exists for the Fed manipulating long-term rates during times of severe economic crisis or war, we are not facing this today.
From an investment perspective, the prospect of the Fed actively pursuing a "third mandate" to maintain "moderate long-term interest rates" could be a significant positive for longer duration bond portfolios, such as those run within the EPIC Fixed Income Strategy. This policy would essentially create a floor for bond prices, reducing the risk of capital losses from rising rates and making longer-dated bonds “safer” and more “stable”. Any central bank intervention to cap yields would inevitably drive-up bond prices, offering a more predictable and potentially lucrative outcome for long-term bondholders.
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