VCIT - Breaking A 200-Year Record: The Unprecedented Decline Of 10-Year Treasury Notes

2023-10-17 10:11:44 ET

Summary

• Treasury bonds have performed poorly in recent years, with a 46% decline in bonds with maturities of 10 years or more since 2020.
• 10-year notes may have three consecutive annual negative returns for the first time in over two centuries, with a current YTD decline of 3.26%.
• The inverted yield curve dilemma poses uncertainty for the bond market, as investors debate the possibility of a recession or a soft landing.

The bond market has had a rough past few years. 2022 was the worst year for bonds in the past 250 years and 2023 hasn't been much better. According to Bloomberg, Treasury bonds with maturities of 10 years or more have fallen 46% since 2020. Since the beginning of 2020, the total return and price of BND, a total bond market index ETF, have fallen 10.03% and 17.15% respectively.

While the entire bond market has performed very poorly throughout the last several years, something very interesting is going on with 10-year notes.

What's going on with 10-year notes

10-year Treasuries may meet a disheartening milestone this year. The 10-year note has not had three consecutive annual negative returns since 1787 . We have already had two in a row and if the return in 2023 is negative, this streak will be dead.

Currently, the 10-year note is down 3.26% YTD. 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; I am confident that the 10-year note will make history by closing 2023 in the red. There has been no indication by the Fed that there will be aggressive rate cuts. In fact, the Fed has forecasted one more rate hike in 2023. I have no reason to believe that the 10-year note will have a rally to close the year in the green.

The inverted yield curve dilemma

Most investors are aware of the yield curve inversion. As the market debates whether or not we are going to go into a recession or have a soft landing, the yield curve is in a very awkward situation. The yield curve is inverted because the market expects yields to go back down in the future. But if we have a soft landing, and rates stay higher for longer, how will the inversion fix itself? The longer-term rates will have to rise above that of ultra-short rates to fix the curve.

The issue here is that it isn't clear which scenario is going to be the outcome. Right now investors are starting to price in higher for longer. This is hurting the 10-year note. But at the same time, investors know that if rates are higher for longer the economy will tighten, potentially leading to a recession which is keeping the yield inverted. Since I've given my forecast that the 10-year note will be negative in 2023, breaking an extremely long streak, let's discuss my forecast of what's likely to happen in 2024.

The Dot Plot and 2024

The Fed dot plot is a chart created by Fed governors. It shows their predictions for the average Fed funds rate for the year.

Right now, the dot plot indicates two 25bps rate cuts in 2024. I think this is an underestimate. I still believe that it's likely we see a recession in 2024. Eventually, these higher rates will slow the economy and cause it to enter a mild recession. Once this happens, the Fed will have to cut rates, likely by more than 50bps. I don't think rates will be cut to near zero, as was the case for most of the past decade, but they will be cut substantially from where they are now. This will cause bond prices to increase. I think the 10-year note will likely see positive returns in 2024 due to this.

Future outlook and silver lining

Sometime in 2024 10-year bonds will be a great investment in my view. The tricky part is knowing when exactly to buy. I'll be sure to cover this topic closely and give my opinion when I believe they become a buy. In the meantime, there is a great place to park your cash while you wait.

Many ultra-short assets are yielding over 5% practically risk-free! You can take advantage of this by investing in Money Market Funds, ultra-short bond ETFs, or individual t-bills. If you don't like uncertainty and are risk-averse, these assets are a great place to put your money while you wait for the long-term bond market to turn.

Takeaways

After an abysmal past few years for the bond market, 10-year notes are about to meet a disheartening milestone. Since 1787, the 10-year note hasn't had three consecutive years of negative returns. However, if 2023 closes in the red, which is likely, this long-standing streak will be broken. I believe the 10-year note will have a positive return in 2024 because a recession is likely to occur, prompting rate cuts. If you want to avoid all this uncertainty, ultra-short assets are a great choice.

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