Bond investors brace for recession as Fed expected to slow pace of tightening

Recession worries are sending investors into Treasuries and other fixed income investments ahead of the Federal Reserve's first meeting of 2023, even as stocks start the year with a hopeful rally.

Yields on the benchmark U.S. 10-year Treasury note, which move inversely to prices, have fallen by around 83 basis points from their October high of 4.338% and investors sent $4.89 billion into U.S. bond funds last week, the third straight week of net inflows. The rally comes after Treasuries notched the worst year in their history following the Fed's most aggressive monetary policy tightening since the 1980s.

Worries that the Fed's rate increases will send the U.S. economy into a recession have been a key driver of demand for Treasuries, often seen as a safe haven during economically uncertain times.

While investors widely expect the Fed to raise rates by another 25 basis points at the end of its monetary policy meeting on Feb. 1, markets are also looking for signals that the central bank is pulling back on its hawkish monetary policy amid signs of falling inflation and softness in the economy.

Things are coming off the boil here," said Rob Daly, director of fixed income at Glenmede Investment Management. "There is a de-risking that's happening, and we're seeing flows out of equities into higher quality parts of the market such as fixed income."

That move has stood in contrast to a recent rally in stocks, where recession concerns are less apparent and hopes of a so-called soft landing, where inflation eases and growth remains resilient, have emerged.

The S&P 500 (.SPX) has risen 4.6% year-to-date and the Nasdaq Composite (.IXIC) is up nearly 9% in a rebound that has lifted many of the names that were beaten down in last year’s equity rout.

Some equity investors are nevertheless playing it safe, expecting the current rally in stocks to wilt if a recession hits.

U.S. equity funds have witnessed outflows for ten straight weeks, even as indexes charge higher, with investors pulling some $1.14 billion in the latest week, according to Refinitiv Lipper data.

Phil Orlando, chief equity strategist at Federated Hermes, is sitting in Treasuries, cash and other defensive investments in anticipation of a reversal in the current rally in stocks.

"Our sense is that stocks are (going)lower and we need to maintain a defensive posture," he said.

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