BlackRock Grows Cautious About Long-Term Treasury Notes and Bonds

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If you have wondered if we are in a bond market bubble with insultingly low interest rates, maybe you should hear what one of the top bond managers has to say on the matter. BlackRock, Inc. (NYSE: BLK) has issued its weekly commentary, and “Rethinking the role of Treasuries” pretty much says what you might expect.

BlackRock’s Richard Turnill, who is the firm’s Global Chief Investment Strategist, has said in the weekly commentary that the firm is cautious on long-term U.S. Treasuries. He sees a declining safety cushion against the risk of steeper yield curves.

Several issues have come into play here. The Federal Reserve has now indicated that a rate hike is likely in December, while upcoming U.S. inflation data may shed light on whether the Fed’s mandated 2% inflation target is looking more real. The Bank of Japan also has shifted its policy to steepen the local yield curve.

Turnhill’s report warns to be cautious about long-term Treasury bonds. He said:

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.

BlackRock’s fixed income class of asset reviews still look neutral as a class as a whole. Still, the view is that U.S. equities have elevated valuations and that further gains will require a meaningful improvement in earnings.

Investors need to understand the measurement of duration against a portfolio. This is effectively how much each maturity might lose if rates were to unilaterally rise or fall by 1%. Turnhill shows just how dire this warning is:

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.

BlackRock’s weekly view goes further into warnings that there is a higher price being paid for long-term insurance. Monday’s report said:

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.

With its iShares exchange traded fund family, BlackRock is easily among the world’s most dominant asset managers, and it dominates in many subsectors of asset management. As of June 30, 2016, BlackRock’s total assets under management sum was listed as $4.89 trillion. That is a rather large sum of assets under management.

This is not the first word of caution about how investors should brace for a rise in interest rates. It also won’t be the last. Just be sure not to get caught off-balance before the trend starts to take hold — or should we warn IF it can FINALLY take hold