Tighter lending conditions after recent bank failures will likely drive the U.S. economy into a shallow recession in the second half of this year, bolstering the case for a gradual increase in exposure to long-term bonds in anticipation of a decline in interest rates, a Vanguard executive said on Monday.
“That backdrop of tightening lending standards is what we think drives the economy into recession in the second half of this year,” said Roger Hallam, global head of rates at Vanguard, the world’s second-biggest asset manager, speaking during an online event.
U.S. Treasury Secretary Janet Yellen said this weekend banks are likely to become more cautious and may restrict lending further, possibly negating the need for further interest rate hikes by the Fed.
Traders in money markets on Monday were largely expecting the U.S. central bank to increase rates by an additional 25 basis points at its next rate-setting meeting in May.
But there was less conviction on subsequent steps with investors pricing in multiple scenarios, including potentially a rate cut as early as June, according to CME Group data.
“There’s a lot of policy uncertainty right now,” said Hallam, who expects volatility in rates to remain high in the short term, with potentially still some upward pressure on yields on the short-end of the U.S. Treasury curve
Bond yields, which move inversely to prices, tend to decline during economic downturns.
Current levels for benchmark 10-year Treasuries - which on Monday were yielding nearly 3.6% - would be a “reasonably good opportunity” for investors to start extending the duration of their portfolios, Hallam said, to offset declines in risk assets such as stocks that are likely to occur in a recession.
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