Will Bonds Continue To Chop?

Assessing The Mechanics Of Mean-Reversion In Bonds

The best information we can ever provide investors is the mechanics of how we think about macro conditions over time, rather than what we think about them at any particular time. Consistent with this idea, we present our Macro Mechanics, a series of notes that describe our mechanical understanding of how the economy and markets work. These mechanics form the principles that guide the construction of our systematic investment strategies. We hope sharing these provides a deeper understanding of our approach and ongoing macro conditions.

US Treasuries have been some of the most challenging markets to navigate for investors over the last few years. The weakness in bonds began in 2022, with the Fed’s initiation of one of the fastest and largest tightening cycles in decades. The hiking cycle in itself caused significant damage to the treasury market, leading to drawdowns we haven’t seen since the 1970s in fixed income markets. However, to the surprise of market participants, bond markets did not recover and continued to face significant chop for several years, crowned by treasuries actually falling as the Fed began its easing cycle in late 2024.

These conditions created a somewhat novel dynamic relative to the long-term history of bonds: one where the price action in bonds was dominated by mean reversion. Those expressing views in line with these mechanics were significantly rewarded, with mean reversion strategies far outperforming simply holding bonds. We visualize this outperformance below, from the prior peak in the Fed Funds rate in 2023:

In this note, we discuss the reasons we think this anomaly has existed, and most importantly: we evaluate whether it can continue.

Let us begin with our decomposition of bond returns sources over time: