A tough quarter for bonds

The bond sell-off may be nearing its worst point because Treasury yields have risen enough to reflect stronger growth, inflation and fiscal risks, although markets remain unsettled.

• US Treasury yields rose 54 basis points at both the 2-year and 10-year maturities and 40 basis points at the 30-year maturity during the third quarter.
• The Bloomberg US Treasury index lost 3.04% in the quarter and 2.77% year to date, while the Bloomberg Aggregate Index fell 3.51% and 2.91%, respectively.
• Yield pressures came from projected third-quarter US growth of 3.7% according to Atlanta Fed GDPNow and 2.8% according to Bloomberg consensus, high oil prices linked to the Iran and Ukraine conflicts, AI infrastructure spending, large fiscal deficits and tighter Fed policy.
• The 10-year Treasury yield ended September at 5.28%, while the 2-year yield reached 4.89%, pricing nearly four additional 25-basis-point Fed hikes over the following year.
• With expected real growth of about 2.2% over the next two years and 2.5% two-year inflation expectations, expected nominal growth is about 4.7%, below the 10-year yield; comparable 10-year yields also rose 26 basis points in Germany, 21 in Japan and 36 in the UK during the quarter.

Takeaway: Treasury valuations may now be sufficiently cheapened to limit further losses, and investors could gradually rebalance toward fixed income, but persistent deficits, geopolitical risks, possible additional Fed hikes and elevated volatility argue against calling an immediate bottom.