Vanguard Bought Large Banks' Bonds On The Cheap During March Turmoil

Vanguard, the world's second-largest asset manager, increased exposure to large bank's bonds during the banking rout in March, taking advantage of cheap valuations, according to a report seen by Reuters.

The collapse of two U.S. regional banks last month triggered wild price fluctuations across fixed income markets, with worries over the banking sector weighing broadly on corporate bond prices.

"The banking troubles offered a brief window to add large banks at compelling valuations," said the report, written by Sara Devereux, global head of fixed income group, and her team.

"We had little exposure to troubled banks and do not see evidence of a systemic risk to the financial system," it said.

Vanguard expects volatility in bond markets to continue in coming months, which could present more opportunities to buy oversold debt securities, but it remains cautious about adding risk to its bond portfolios as it expects the economy to enter a recession this year.

"The time for a full risk-on moment has not yet arrived," the report said.

Last month's bank failures have strengthened expectations of a slowdown in the economy, as banks are expected to become more cautious and restrict lending.

Investors are now assessing whether the Federal Reserve will keep hiking rates to fight inflation after a largely expected 25 basis point hike at its next rate-setting meeting in May. Many expect the central bank to cut rates later this year to loosen the grip of higher borrowing costs on the economy.

Core inflation, however, is likely to be sticky, according to Vanguard, limiting the Fed's ability to ease monetary policy in coming quarters.

"We believe the Fed will ultimately hoist the fed funds rate above 5% by mid-year before pausing," it said.

"Barring a major economic surprise, we think the Fed will hold policy rates high for longer than the market currently expects."