Market’s obsession with US yield curve could backfire: BlackRock

Chief bond strategist says instead of worrying about a recession, investors should focus on rebalancing portfolios
Business Insider

The yield spread on US 2-year and 10-year treasuries is getting flat. When it inverts, history says a recession usually follows.


Should we be worried about a downturnRupee

Well according to the chief bond strategist at $US6 trillion asset manager BlackRock, that’s not actually the right question to be asking.

Rather, Jeffrey Rosenberg warns that amid all the recent hype about the yield curve, investors could be missing the main game.

Of more importance: Competition for huge global capital flows is heating up in an environment of rising rates. So instead of sweating on the 2-10 spread, smart investors should be considering how to position their portfolios accordingly.

“The only thing more persistent than the flattening yield curve has been market fears about the yield curve,” Rosenberg said. “But this attention may be misdirected.”

To illustrate his point, Rosenberg compared different fixed income products using two factors — investment returns and relative volatility — for both 2012 and 2018.

In 2012, the US Fed had its foot on the quantitative-easing pedal with official cash rates anchored at zero. Fast-forward to 2018 and the “riskfree” rate has climbed to 2per cent.

The composite line for different fixed income returns in 2018 is much flatter than it was in 2012.

Back then, more capital moved into high-risk debt instruments as investors went on the hunt for yield.

Riskier corporate bonds (“US high yield”) gave a return of around 6per cent in 2012 — equal to the premium over official cash rates, which were anchored at 0per cent.

Fast forward to this year, and US high yield debt is still returning around 6per cent, but benchmark interest rates have risen to around 2per cent.

The higher spread in 2012 was a symptom of the Fed’s policy stance, as it boosted the economy with unprecedented levels of fiscal stimulus. But according to Rosenberg, a critical question remains unanswered: “What happens to markets as this process goes in reverseRupee”

The Fed is hiking rates now, and yields on shorter-term US Treasuries (including 2-year debt) have risen accordingly.

US treasuries are still seen as one of the safest places to park your money, so all of a sudden that government debt is looking more attractive. The resulting shift has contributed to “bursts of volatility in global fixed income markets”, Rosenberg said. “WhyRupee Attractive yields on these assets are heating up the competition for capital.”

Rosenberg noted that the Fed is taking a gradual approach to normalisation and being clear in its policy guidance, in order to avoid market disruption.

Nevertheless, “portfolio rebalancing in reverse is a tricky process”, he said. “The volatility we’ve seen so far this year - also a result of trade disputes and potential US economic overheating - suggests a more cautious approach to fixed income investing is warranted.”