The start of the next Federal Reserve (Fed) easing cycle now seems imminent, raising questions about the performance of longer-dated Treasury bonds—those with 20-year and 30-year maturities. What is the best time to position in long-duration bonds?
This chart shows the excess return on long-term U.S. Treasuries versus cash. The dots on the chart indicate federal funds rate cuts, while gray shading denotes recessions. The period between 1986 and 2021 was unusually favorable for fixed income, and the trend of 4.6% annualized excess return seen during that time likely will not be repeated in the future. Instead, the focus should be on when bonds have performed well—or poorly—compared to the overall trend.
Longer-duration bonds have not performed particularly well at the start of Fed policy easing cycles with the exception of 1984-1986, when the Treasury yield curve was upward-sloping at exceptionally high real rates. Even during recessions in 1990, 2001, and the first half of 2008, long bonds struggled at the beginning of the easing cycle.
Historically, long-term bonds have done particularly well once the Fed cuts rates substantially, the yield curve is very steep, and the economy is relatively slow to respond to monetary stimulus. Examples can be seen in 1992-1993, 2002-2003, and 2010-2013.
As one would expect, long bonds also have performed well in response to large exogenous shocks. For instance, long-term Treasuries performed well in the wake of the following crises: Black Monday stock market crash in October 1987; Russian debt default and Long-Term Capital Management (LTCM) bailout in 1998; Lehman Brothers bankruptcy in 2008; China currency devaluation and capital flight in 2015; and the COVID-19 pandemic in the first quarter of 2020.
Finally, long bonds often do well in anticipation of Fed easing cycles. For example, long-dated Treasuries performed strongly in the first halves of 1989, 1995, and 2019, respectively, and during 2000, just before the Fed began cutting rates.
The key takeaway from this analysis is that unless a large financial shock occurs, long-duration bonds might struggle to outperform shorter-duration bonds in the early stages of the Fed easing cycle. This potential underperformance could be more likely given how flat the yield curve is now.
Paul Mielczarski
Head of Global Macro Strategy & Portfolio Manager
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