Worst Return in Over a Century Meets a 5% Yield
TREE NEWS reports: The US Treasury market is enduring its most punishing return cycle in more than 100 years, yet the very yields that have crushed existing holders are drawing fresh capital back into fixed income. The 10-year Treasury yield briefly broke above 5% this week, a 19-year high, after the Federal Reserve’s new chair, Warsh, announced the first rate hike in three years to combat inflation that remains stubbornly above target.
Goldman Sachs strategists led by Christian Mueller-Glissmann estimate that the five-year rolling return on 10-year Treasuries has fallen to its weakest level in over a century. Even before adjusting for inflation, nominal returns are dismal; on a real basis, the report describes the outcome as “almost as bad as” the periods following World War I, World War II, and the 1970s stagflation.
The Double Squeeze: Inflation and Rate Hikes
The Bloomberg Aggregate Bond Index — widely regarded as the bond market’s equivalent of the S&P 500 — is down 1.6% year-to-date on a total-return basis through last Wednesday’s close. The index covers Treasuries, corporate bonds, mortgage-backed securities, and other government-backed debt, but excludes ultra-short Treasury bills. It oscillated between gains and losses early in the year before sliding steadily from August as global crude climbed toward $100 a barrel. Higher oil prices lift inflation expectations, directly eroding the real purchasing power of fixed-income assets, with the impact most severe on longer-duration bonds.
DWS Americas fixed income head George Catrambone attributes the situation to two forces: the Fed and the market have “lost patience” with inflation running above target, and a protracted Iran conflict continues to weigh on markets.
The 5% Threshold: A Signal for New Money
While the sharp rise in yields has battered existing holders, it has created more attractive entry conditions for new capital. “The higher the yield, at least for new money, the more enticing it is to put money into bonds,” said Brian Rehling, co-head of global fixed income strategy at Wells Fargo Investment Institute.
Cullen Roche, founder and chief investment officer of Discipline Fund, echoes that view. He notes that the poor bond returns of the past five years stemmed from starting yields that were already low, with interest-rate risk overstated. Five years ago, the 10-year Treasury yielded about 1.3%. “But as yields rise and prices fall, these assets become more attractive,” he said. Roche likens buying long bonds now to purchasing a discounted used car — the pace of price declines slows over time, while the fixed coupon income does not change with market prices.
Bob Michele, CIO at J.P. Morgan Asset Management, has also said his team has begun buying long-dated government bonds in the US, Japan, and Australia, viewing current prices as “extremely cheap.” He points to policy coordination among the European Central Bank, the Fed, and the Bank of Japan as forming a support chain for the bond market, with a long-bond buyback program launched by Bessent seen as a key stabilizing force. The policy toolkit still has room to expand, he argues.
Fund Flows: Short Duration Favored, Long Bonds Shunned
Despite broad bond-market stress, inflows have not stopped — but the composition is clearly split. US bond funds have logged 71 consecutive weeks of net inflows. Short-term bond funds absorbed capital equal to 12.2% of assets (about $139.9 billion) during that stretch, while long-term bond funds took in only 2.9% of assets (about $19.3 billion).
Notably, these inflows occurred even as short-term bonds were roughly flat and long-term bond fund net asset values fell nearly 5%.
Optimism still warrants caution. The Fed forecast on Wednesday that inflation could end the year near 3.7%, and would not return to the 2% target until 2029. Asked about the Treasury selloff, Warsh attributed pressure to multiple global “hot spots” and other factors, stressing that the 10-year Treasury is “the world’s most important asset” and “the risk-free benchmark for pricing almost everything.”
Roche is candid: “Long bonds still carry risk, but they have become more attractive; short bonds are already very attractive.” The trajectory of the Iran war and whether inflation can fall as expected remain the two biggest variables hanging over the bond market.
Key Takeaways for Investors
- Yields are doing the work: With the 10-year above 5%, income-oriented investors are being compensated far better than at any point in nearly two decades.
- Duration is a double-edged sword: Long bonds offer the most upside if inflation cools, but remain exposed to further rate hikes and oil-driven inflation surprises.
- Flows favor the short end: The 71-week inflow streak is concentrated in short-duration funds, suggesting investors want yield without taking excessive duration risk.
- Watch two variables: The path of the Iran conflict and the Fed’s inflation trajectory — neither is resolved, and both will drive the next leg for Treasuries.
