AGG - An Update On 10-Year Treasuries And A Look Into 2024

2024-01-12 10:03:09 ET

Summary

• The 10-year Treasury note recorded a positive return in 2023, saving a 200-year record of consecutive annual declines.
• November and December 2023 saw significant gains in the bond market, breaking a 20-year record for the largest 2-month gain in two decades.
• The bond market has faced challenges in recent years, but the end-of-year rally suggests a potential positive outlook for 2024, although there is uncertainty due to conflicting economic data.

Back in October of last year, I wrote an article titled Breaking A 200-Year Record: The Unprecedented Decline Of 10-Year Treasury Notes. In this article, I talked about how the 10-year note has not had three consecutive annual negative returns since 1787 . I should point out that while traditional 10-year bonds haven't existed for that long, economists use unconventional indexes that use a variety of data from the past to make proxy 10-year bonds.

In 2021 and 2022 the ten-year note return was negative. At the time of writing my previous article, the 10-year was down about 3 and a quarter percent. In the article, I said "It's very likely that the 2023 return will close in the red. For the 10-year note to close positive, there would likely have to be multiple rate cuts this year. And that is very unlikely."

According to the S&P U.S. Treasury Bond Current 10-Year Index , the 2023 10-year note closed with a 2.74% increase, saving the record! Let's take a look at how the 10-year was able to claw its way back to record a positive 2023.

It took breaking a 20-year and an almost 40-year record to save a 200-year record

While almost breaking the record for three consecutive years of decline in 10-year notes is disheartening, 2 more positive records were broken. November 2023 was the bond market's best month since 1985 after 10-year yields peaked at 5% in late October. The rally didn't stop there. December was good too. In fact, November and December combined for a total return of 6.9%! This broke a record for the largest 2-month gain in 2 decades.

The 10-year rally was truly amazing. In October, the 10-year recorded its 2023 low of $458.58. From there, it rallied 10.07%! This saved the 200-year record.

The big picture

While November and December were great months, the past few years have still been rough for bond investors. The Fed raised rates very fast and raised them to highs we haven't seen for decades. This destroyed the bond market. 2022 was the worst year for bonds in the past 250 years.

Since January 2021, the bond market represented by BND , a total bond market ETF, is still down 10.5%.

What's in store for 2024

After an impressive end-of-year rally for bonds, is it going to continue into 2024? I think the 2024 bond market is likely going to end in the green. With that said, I think the end-of-year rally was overdone. Here is an excerpt from WSJ that sums up the situation pretty well.

"It's fair to say the bond-market rally went too far," said Matt Peron, director of research and global head of solutions at Janus Henderson Investors. "Six expected rate cuts implies the economy is nosediving, but we're experiencing more gradual disinflation."

Futures markets tied to the fed-funds rate show traders expect the central bank to kick off easing in March. Fed officials forecast roughly three cuts for this year at their December meeting.

"Going forward, 'higher for longer' will probably re-enter the lexicon," said Andrew Patterson, senior international economist at Vanguard.

Vanguard does not expect any rate cuts in the first half of 2024. I think their prediction may go too far. I'm skeptical of there being 6 rate cuts, but I think 4-5 is reasonable. The Feds forecast of 3 seems too low.

With the presidential election, trouble in the Middle East, and rising US debt concerns, 2024 is bound to be hectic. Because of this, I think it makes more sense to do a first half of 2024 forecast and then reevaluate at the start of the third quarter. There are likely to be 1 or 2 rate cuts in the first half of 2024. As inflation continues to go down (notwithstanding today's slightly hotter-than-expected CIP report), the Fed will need to cut rates so that the real rate stays the same. Also, as the economy slows, the Fed will want to ease their monetary policy so they don't push the US into a recession. I forecast the total bond market ( BND ) finishing the first half of the year with somewhere around a 3% gain. So BND has a good yield with capital appreciation potential.

Why is there so much confusion

Predicting interest rates in 2024 is particularly challenging because there has been a lot of conflicting data that is hard to decipher. We are in very confusing times. The market was almost certain of a recession, but now it appears the Fed may have pulled off a soft landing. Inflation was over 9% and the Feds fund rate was raised to over 5% extremely fast. This would be expected to almost certainly cause economic turmoil, yet the economy is chugging along. In January, we had our latest set of conflicting data. The PMI fell to 50.6 last month, which is the lowest reading since May. A PMI reading of anything above 50 indicates growth in the services industry, an industry that accounts for over 66% of the economy. So a reading of 50.6 is awfully close to a stall in growth.

The PMI data seems to suggest that the Fed's attempt to slow the economy is working. But the Labor Department's payroll report for December told another story. Employers hired more workers than expected. This suggests the Fed's effort to slow the economy still hasn't worked as expected.

What this means

So after a historically poor performance in 2021 and 2022, 2023 ended with a solid rally. The rally may have been overdone, especially considering data is providing mixed signals pointing to both a slowing economy and a hot economy. This is a developing situation and as more data comes out, we will hopefully be able to get a better idea of what's to come. For now, I still believe there will be multiple rate cuts in 2024 and the bond market will close the year in the green.

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