As investors continue to discuss the uncertainty surrounding the U.S. Treasury market, there may be some good news for bond holders as the year progresses.

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Welcome to Thoughts on the Market. I'm Michael Zezas, Head of Public Policy Research and Municipal Strategy for Morgan Stanley. Along with my colleagues bringing you a variety of perspectives, I'll be talking about the intersection between U.S. Public Policy and financial markets. It's Wednesday, April 13th at 10 a.m. in New York. 

It's been a tough year for bond investors so far. As inflation picked up, the Fed signaled its intent to hike rates rapidly. That pushed market yields for bonds higher and prices lower. And with the latest consumer price index showing prices rose 8.5% over the past year, bond investors could, understandably, be concerned that there's still more poor returns to come. 

But we're a bit more optimistic and see reason to think that bonds could deliver positive returns through year-end and, accordingly, play the volatility dampening role they typically play in one's multi-asset portfolio. Accordingly, our cross-asset team is no longer underweight government bonds. And our interest rate strategy team has said that the recent increase in longer maturity bond yields have put that group in overshoot territory. 

What's the fundamental basis for this thinking? In short, it has to do with something economists typically call demand destruction. Basically, it's the idea that as prices on a product increase, perhaps due to inflation, they reach a point where fewer consumers are willing or able to purchase that product. That in turn crimps economic growth and, accordingly, one would expect that longer maturity bond yields would rise less, or perhaps even decline, to reflect an expectation of lower inflation and economic growth down the road. 

And we're starting to see evidence of that demand destruction. Last week we talked about how the federal government was attempting to reduce the price of oil by selling some of its strategic petroleum reserve. But it's noteworthy that the biggest declines in the price of oil from its recent highs happened before this announcement, suggesting that the price surge at the pump was already crimping demand, resulting in prices having to come back down to put supply and demand in balance. You can also see similar evidence in the market for used cars. For example, used car dealer CarMax reported this week its biggest earnings miss in four years. Management cited car affordability as a key reason that it sold less cars year over year. 

So the bottom line is this: bond investors may have taken some pain this year, but that doesn't mean it's time to run from the asset class. In fact, there's good reason to believe it can deliver on its core goal for many investors, diversification in uncertain markets. 

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