(Bloomberg) — Treasury bonds staged a relief rally last week after Federal Reserve policymakers sent reassuring signals about rate cuts this year, helping the market recover from a mini-rout leading up to the meeting. For Greg Peters, it was the same old story.
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Peters, who helps oversee about $800 billion as co-chief investment officer at PGIM Fixed Income, says this back-and-forth has become all too familiar over the past year as traders piled in and out of bets for aggressive monetary easing, at times sending the market swinging wildly.
“I have officially grown exhausted around the nonstop Fed-speak attention,” Peters said. “Focus on the data — ignore the white noise of the chatter and stop fixing on a single tree when you are lost in the forest.”
By leaving their benchmark policy rate unchanged and maintaining their median forecast for three cuts this year, policymakers validated the “pause, pivot and party-on” mantra of bond bulls, Peters says. PGIM is taking a more neutral position on rates, as the firm sees a volatile environment where it will add Treasuries when yields appear to be peaking and sell on the reverse case. Peters sees the 10-year yield trading between 3.5% and 4.5% in the months ahead. PGIM is also taking historically smaller position sizes.
Peters’ read on the latest data makes him generally constructive on debt markets, but for a different reason than bulls who look for big capital gains. His experience, from the time he began his career as a bank regulator at the Treasury department in the late 1980s through a string of Wall Street positions and up to now at PGIM, has taught him to recognize major turning points — and he sees one now.
Changes in the global economy, a world awash in debt and a Fed hamstrung by increasingly sticky price pressure all point to a structural shift toward higher yields, marking a break from the ultra-low-rate era that was the norm recently. That makes bonds attractive from a buy-and-hold perspective.
“This is a secular shift,” Peters said during an interview this month at the firm’s Newark, New Jersey-based headquarters. “If you look at the data, inflation on balance, at growth on balance, at the deficit being funded on balance, all these things point to higher rates, not lower rates.”
Peters blames the series of overshoots in recent months toward lower rates on “recency bias,” given that many in the market these days cut their teeth under a Fed that was quick to pivot toward slashing rates. He aligns with views of other long term investors — such as Bill Gross the co-founder of bond giant Pacific Investment Management Co., warning not to expect a tumble in bond yields, even when monetary easing does begin — and even sees the prospect of the Fed cutting rates “in the face of above-trend inflation.”
The 10-year US Treasury yield that serves as world’s global benchmark rate, driving the value of more than $50 trillion in assets, sits at about 4.3% —- well above last year’s low of 3.25%.
US Treasury Secretary and former Fed Chair Janet Yellen said earlier this month that yields were unlikely to go back to being as low as they were before the Covid-19 and former Treasury Secretary Lawrence Summers stressed that even the Fed’s neutral policy rate – one that doesn’t stoke or temper demand — is higher now.
Fed officials for their part slightly lifted their forecasts at last week’s meeting for where they see rates over the long term, boosting their median estimate to 2.6% from 2.5%. The change implies rates will need to stay higher for longer.
PGIM’s chief US economist Tom Porcelli forecasts that the Fed will cut rates three times this year, in line with market and Fed forecasts. But he also sees an under-appreciated outlier risk that growth will surprise on the upside if the recent burst in productivity persists amid advances in AI.
As co-head of fixed income Peters helps guide some 16 funds. One bright spot among them is the $3.7 billion PGIM short duration fund, which has gained 6.6% in the past 12 months — outperforming 92% of peers. PGIM’s $44.4 billion total return fund has lagged a majority of peers while outperforming the Bloomberg Aggregate index over the past 12 months and on a three- and five-year basis, according to data compiled by Bloomberg. In 2023, the fund’s return was 7.7%, ahead of the benchmark’s rise of 5.5%, according to the firm’s data.
Even with the prospect of increased volatility, Peters says the reset higher in yields should help boost the appeal of bonds. “When you start with a higher yield, your potential for return is higher, because it is about the carry you get in,” Peters said. “And so I think we’re in a much more normal asset allocation balance.”
The environment should favor active managers who can take advantage of the broader yield dispersion in markets now than when rates were uniformly low, Peters says, but “it’s incumbent upon us to capture it.” PGIM’s total return fund attracted a combined inflow of $908 million during the first two months of this year, with February marking the biggest month of new cash since August, according to data from Morningstar.
More broadly, money has surged into actively managed bond funds this year in a reversal from 2023. All US bond and exchange-traded funds have attracted inflows of $183 billion this year through March 15, with active mandates gaining the majority of that, according to EPFR.
–With assistance from Sam Hall.
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