(Reuters) - U.S. asset manager Vanguard is bullish on longer-dated Treasuries after this year's brutal selloff, betting that the Federal Reserve is at the end of its rate hiking cycle and that the economy will slow next year.
Despite a "cruel summer for bond investors," long-term bonds continue to remain attractive as the economy will likely enter a shallow recession next year, the world's second-largest asset manager said in a fixed income outlook seen by Reuters.
U.S. Treasury yields, which move inversely to prices, have risen sharply over the past few months, with benchmark 10-year Treasury yields trading above 5% on Monday for the first time since 2007.
An economic slowdown, in theory, would force the Fed to cut borrowing costs, pushing down prices of shorter-dated Treasuries as they are more sensitive to interest rates and heightening the appeal of longer-dated bonds.
"The relative advantage short-term government bonds have can fade quickly, and investors can fare better when they lock in higher rates for longer," Vanguard said.
Vanguard's call comes as another big investor, Pershing Square Capital Management's Bill Ackman, said on Monday that he covered his bet against longer-term bonds, saying it was too risky to remain short bonds at current long-term rates.
Expectations that the Fed will cut interest rates to boost an economy hit by much higher borrowing costs have been pushed out several times this year, as economic activity has remained surprisingly resilient to the interest rate hikes delivered so far by the U.S. central bank as it seeks to curb inflation.
Vanguard said it expects interest rates will not be cut until at least mid-2024, and that bond yields will not return to the low levels that characterized the U.S. bond market in recent history.
But Vanguard said it also believes the Fed is at or near the end of its hiking cycle, which makes long-term bonds attractive both for their high yields and for the potential of capital appreciation in case of an economic slowdown.
"We believe we are in a new era for fixed income in which bonds offer significantly more value - both in total returns and as better ballast within an overall portfolio," Vanguard said.
On the credit side, Vanguard is optimistic on highly rated companies as it believes they continue to have strong fundamentals after they managed to either not borrow or to borrow short-term debt, avoiding higher funding costs for long.
"We view high-quality corporates as one of the more attractive places to be in credit," Vanguard said.
By Davide Barbuscia
Editing by Ira Iosebashvili and Will Dunham
