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Investors may be overlooking a significant shift in fiscal policy that could benefit long-term bonds and rate-sensitive sectors. According to Bank of America’s chief investment strategist, Michael Hartnett, the potential for tighter government spending and stabilizing yields presents an attractive opportunity for bond investors. Over the past two years, fixed-income assets have struggled due to rising interest rates and higher deficits. However, Hartnett believes that the tide is turning, with yields approaching peak levels and a more cautious stance from the Federal Reserve. He also highlights the historical performance of U.S. Treasuries, which have never had negative 10-year returns over the past nine decades.

The Turning Tide in Bond Markets

Hartnett argues that the recent surge in yields has created a favorable environment for bond investments. Corporate bonds now offer competitive yields, making them attractive to pension funds and other institutional investors. He recommends focusing on long-duration bonds, particularly those tracked by the iShares 20+ Year Treasury Bond ETF (TLT). The slowing of U.S. government spending and the Federal Reserve's cautious approach to inflation are key factors supporting this view. If yields retreat toward 4%, diversified low-risk bond portfolios could generate annualized returns of 11%-12%. Higher-risk allocations might yield up to 15%.

Historically, U.S. Treasuries have shown resilience, with no negative rolling 10-year returns in the past 90 years. The technical indicators also suggest stability, as the 30-year Treasury yield has hit a double top at 5%, indicating strong resistance. Hartnett believes that if yields drop 100 basis points, the bond market could see strong returns, even if yields rise modestly. With current yields near 5%, the worst may be over for bonds, presenting a "very good" risk-reward profile.

Fiscal Policy Shift Under Trump

Hartnett points out that the U.S. budget deficit has risen sharply, reaching $7.3 trillion, significantly boosting nominal GDP. Government spending has been a major driver of economic growth. However, with the Federal Reserve prioritizing inflation control and the likelihood of Donald Trump pushing for spending cuts, deficits could shrink, reducing upward pressure on yields. This scenario could lead to what Hartnett calls the "twin peak" in 5% bond yields. Scott Bessent, Trump's nominee for Treasury Secretary, emphasized during his Senate confirmation hearing that addressing government spending will be a top priority. He highlighted runaway spending as a key reason for joining the Trump campaign, signaling a commitment to aggressive fiscal tightening.

Bessent’s focus on reducing government outlays aligns with a broader shift toward fiscal discipline. This change could stabilize or even lower yields, benefiting long-term bondholders. Investors looking to capitalize on this trend should consider rate-sensitive exchange-traded funds (ETFs) such as the SPDR S&P Homebuilders ETF (XHB), Utilities Select Sector SPDR Fund (XLU), Financial Select Sector SPDR Fund (XLF), and SPDR S&P Biotech ETF (XBI). These sectors stand to gain from lower mortgage rates, defensive dividend-paying stocks, a steepening yield curve, and reduced borrowing costs, respectively.