GLOBAL WEEKLY COMMENTARY

Rethinking the role of Treasuries

Sep 26, 2016 / By Richard Turnill

Key points

  • We are cautious on long-term U.S. Treasuries, amid a declining safety cushion against the risk of steeper yield curves.
  • The Federal Reserve (Fed) indicated a likely December rate rise, while the Bank of Japan (BoJ) shifted policy to steepen the local yield curve.
  • U.S. inflation data this week could shed some light on whether the U.S. economy is any closer to hitting the Fed’s 2% inflation target.

It’s time to rethink the role of U.S. Treasuries in portfolios, and specifically to be cautious of long-duration Treasuries. The risk-reward landscape for long-duration Treasuries is shifting.

Chart of the week
Fixed income safety cushion and volatility, 2016

Fixed income safety cushion and volatility, 2016

Depressed yields mean there is currently little safety cushion for holders of U.S. government bonds. Just a 0.2 percentage point increase in Treasury yields could wipe out a whole year’s worth of yield income. Other fixed income sectors such as U.S. investment grade corporate bonds and emerging market dollar debt offer thicker safety cushions – with similar yield volatility in the past year. See the green and blue bars in the chart above.

A higher price for
long-term insurance

The collapsing cushion comes as long-term yields are starting to rise. We see a steeper yield curve ahead amid a gradual pivot toward fiscal expansion globally, although central banks still have the ability to limit any unwanted yield rises. Major central banks are displaying a tolerance for letting inflation run hotter, and the Fed has adopted a go-slow approach to raising rates. Central banks appear to be approaching limits in the effectiveness of extraordinary monetary easing, as was evident in the BoJ’s shift last week to policy tools that steepen the local yield curve.

U.S. Treasuries are becoming less attractive to non-U.S. investors, as the increased cost of currency hedging is wiping out the extra yield Treasuries offer. Finally, bonds tend to have higher correlations to stocks during periods when markets are concerned about Fed tightening, damaging their traditional role as portfolio diversifiers. This is a risk as the central bank’s December meeting approaches.

Longer-maturity U.S. government bonds still have a role to play – and should buffer portfolios in any flights to safety. But investors today are paying a lot for this diversification benefit. We prefer shorter-term corporate and municipal bonds, whose yields have temporarily spiked ahead of U.S. money market reforms in October. Overall, we favor credit markets and see a role for other portfolio diversifiers such as gold.

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Date: Event
Sept. 26 U.S. August new home sales, first U.S. presidential candidates’ debate
Sept. 27 U.S. September Markit Services PMI Flash, U.S. September consumer confidence
Sept. 29 Germany preliminary September consumer price index (CPI)
Sept. 30 Japan August CPI, preliminary industrial production; U.S. August core PCE (personal consumption expenditures) price index; China September Caixin Manufacturing PMI

The focus this week: inflation data from Germany, Japan and the U.S. Stubbornly low inflation figures in the eurozone and Japan have been a major impetus for ever-greater monetary stimulus. The U.S. core PCE index, the Fed’s preferred inflation measure, could shed some light on whether the U.S. economy is any closer to hitting the central bank’s 2% inflation target. China’s September manufacturing PMI data may further confirm stabilizing economic growth, after the August data unexpectedly showed the fastest pace of expansion in nearly two years. Finally, as the polarizing U.S. presidential campaign enters its final stage, the first debate between Hillary Clinton and Donald Trump may offer clues on who could win the closely contested November election.

 

 

  • The BoJ shifted its policy to target local 10-year government bond yields and steepen the yield curve, while maintaining its asset purchase target.
  • The Fed kept rates unchanged but strongly implied a likely rate rise by year-end as well as a relatively slow and shallow rate-increase path.
  • Japanese financials rallied as the BoJ policy shift included a change in the mix of its equity purchases toward the relatively financials-heavy TOPIX index.

Global snapshot

Weekly and 12-month performance of selected assets

 

EquitiesWeekYTD12 MonthsDiv. Yield
U.S. Large Caps 1.2% 5.9% 11.7% 2.1%
U.S. Small Caps 2.5% 11.6% 11.8% 1.4%
Non-U.S. World 3.2% 6.7% 9.7% 3.1%
Non-U.S. Developed 3.1% 2.4% 6.8% 3.4%
Japan 4.0% 4.3% 11.0% 2.3%
Emerging 3.6% 17.8% 18.6% 2.5%
Asia ex-Japan 3.0% 14.2% 18.1% 2.4%
BondsWeekYTD12 MonthsYield
U.S. Treasuries 0.5% 5.0% 4.5% 1.6%
U.S. TIPS 1.2% 7.2% 6.3% 1.6%
U.S. Investment Grade 0.9% 9.1% 8.4% 2.8%
U.S. High Yield 0.8% 14.7% 10.1% 6.2%
U.S. Municipals 0.1% 4.0% 6.0% 1.8%
Non-U.S. Developed 1.3% 12.9% 11.6% 0.5%
Emerging Market $ Bonds 1.6% 14.9% 14.8% 5.0%
CommoditiesWeekYTD12 MonthsLevel
Brent Crude Oil 0.3% 23.1% -3.9% $45.89
Gold 2.1% 26.1% 18.3% $1,337.6
Copper 1.4% 3.2% -4.0% $4,855
CurrenciesWeekYTD12 MonthsLevel
Euro/USD 0.6% 3.4% 0.4% 1.12
USD/Yen -1.2% -16.0% -16.0% 101.02
Pound/USD -0.3% -12.0% -14.9% 1.30

Source: Bloomberg. As of September 23, 2016. Notes: Weekly data through Friday. Equity and bond performance are measured in total index returns in U.S. dollars. U.S. large caps are represented by the S&P 500 Index; U.S. small caps are represented by the Russell 2000 Index; Non-U.S. world equity by the MSCI ACWI ex U.S.; non-U.S. developed equity by the MSCI EAFE Index; Japan, Emerging and Asia ex-Japan by their respective MSCI Indexes; U.S. Treasuries by the Barclays U.S. Treasury Index; U.S. TIPS by the U.S. Treasury Inflation Notes Total Return Index; U.S. investment grade by the Barclays U.S. Corporate Index; U.S. high yield by the Barclays U.S. Corporate High Yield 2% Issuer Capped Index; U.S. municipals by the Barclays Municipal Bond Index; non-U.S. developed bonds by the Barclays Global Aggregate ex USD; and emerging market $ bonds by the JP Morgan EMBI Global Diversified Index. Brent crude oil prices are in U.S. dollars per barrel, gold prices are in U.S. dollar per troy ounce and copper prices are in U.S. dollar per metric ton. The Euro/USD level is represented by U.S. dollar per euro, USD/JPY by yen per U.S. dollar and Pound/USD by U.S. dollar per pound. Index performance is shown for illustrative purposes only. It is not possible to invest directly in an index. Past performance is not indicative of future results.

Asset class views

Views from a U.S. dollar perspective over a three-month horizon

Table: Asset class views from a U.S. dollar perspective

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Richard Turnill
Global Chief Investment Strategist for BlackRock
Richard Turnill is Global Chief Investment Strategist for BlackRock. He was previously Chief Investment Strategist for BlackRock’s fixed income and active equities business and has also led the Global Equity team. Richard started his career at the Bank of England.
Richard Turnill
Global Chief Investment Strategist for BlackRock
Richard Turnill is Global Chief Investment Strategist for BlackRock. He was previously Chief Investment Strategist for BlackRock’s fixed income and active equities business and has also led the Global Equity team. Richard started his career at the Bank of England.

Isabelle Mateos y Lago

Chief Multi-Asset Strategist

Kate Moore

Chief Equity Strategist

Jeffrey Rosenberg

Chief Fixed Income Strategist