Morgan Stanley bond veteran turns bullish on US Treasuries after 10-year hiatus

A manager with a strong track record is adding duration near current yield highs, making for a contrarian signal in Treasuries, though he acknowledges yields could still rise another 10 to 15 basis points before peaking. His argument hinges on the Federal Reserve's rate-hiking path slowing the economy, so any evidence that energy-driven inflation pushes the central bank to tighten further would undermine it. Oil's relationship with the market cuts both ways: energy prices tied to the Iran war helped fuel the bond selloff, and a fresh surge in crude would intensify inflation pressure and postpone any drop in yields. The widening of credit spreads for weaker corporate and sovereign borrowers suggests tighter financial conditions are beginning to take hold.

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One of Wall Street's top-performing bond managers, who stayed on the sidelines for a decade, now contends that yields near 5.4% pay investors enough to bet that the Fed will break growth before it breaks the bond market.

Key takeaways:

• Vishal Khanduja of Morgan Stanley Investment Management has grown bullish on US government debt for the first time in over ten years
• The roughly $4 billion Eaton Vance Total Return Bond Fund increased its duration to about 6.1 years, above its benchmark's 5.8, its first overweight in more than a decade
• The 10-year Treasury yield has risen roughly one percentage point since June to a 24-year high near 5.4%
• Khanduja expects the hawkish Fed, which raised rates last month and signaled more increases, to slow growth and cap yields, though he sees a potential 10 to 15 basis point overshoot
• Bloomberg data show 10-year yields would need to reach around 6% within a year before price losses exceed coupon income
• The fund has returned close to 3% annually over the past decade, beating 97% of peers, but is down close to 3% this year

A veteran bond investor at Morgan Stanley Investment Management has taken a bullish stance on US government debt for the first time in more than a decade, arguing that yields near two-decade highs now provide enough income to absorb further losses and will eventually weigh on economic growth. Khanduja spoke in a Bloomberg interview.

Khanduja, who co-manages the roughly $4 billion Eaton Vance Total Return Bond Fund with Brian Ellis, said the fund pushed its duration, a gauge of interest-rate sensitivity, to around 6.1 years as of June. That compares with about 5.8 years for its benchmark, the Bloomberg US Aggregate Bond Index, and marks the fund's first overweight duration position in more than ten years. The fund has returned close to 3% a year over the past decade, more than double its benchmark, and has outperformed 97% of Morningstar peers over that period, though it is down close to 3% this year, roughly in line with the index.

His shift follows a punishing stretch for fixed income. Elevated energy prices linked to the Iran war, a resilient US economy, heavy government borrowing and a wave of corporate debt issuance to fund artificial intelligence spending have combined to push the 10-year Treasury yield up by about a percentage point since June, to a 24-year high near 5.4% on Wednesday. Khanduja acknowledged the selloff could overshoot by a further 10 to 15 basis points, but said the firm was adding exposure gradually and described his 12-month conviction as very high.

Central to his outlook is the Federal Reserve, which raised rates last month for the first time in three years and signalled further increases. Khanduja characterised the central bank as a bond vigilante in its own right, arguing that its determination to contain inflation will slow growth and ultimately cap yields. He pointed to early signs of strain in wider credit spreads for lower-rated companies and some sovereign borrowers, including France, as well as pressure on lower-income consumers and leveraged firms.

The arithmetic also favours buyers, in his view. According to Bloomberg data, investors buying 10-year Treasuries at current levels would need yields to climb to around 6% over the next year before price losses outweighed their income. Khanduja said valuations had become very attractive, while noting that the market is still waiting for a clear catalyst to spark a rally, leaving the timing of any turn dependent on evidence that higher borrowing costs are slowing the economy.