Global Weekly Commentary: Favoring short-term bonds long term
We up short-term sovereign bonds on attractive yields and downgrade credit in the long-run. We stay cautious on long-term bonds even with the surge in yields.
U.S. stocks recovered last week as 10-year yields slid from 16-year highs. Jobs data showed a normalizing labor market. We see demographics starting to bite.
China data this week will help gauge fading economic momentum. We see weak consumer and export demand leading to growth below the pre-Covid trend.
Sovereign bond yields have surged this year, with U.S. long-term yields hitting 16-year highs last month. We prefer short-term government bonds over credit. We go underweight high quality credit on a strategic view of five years and longer and trim our overall underweight to sovereign bonds. We still see investors demanding more compensation for holding long-term bonds given higher inflation, greater macro volatility and rising debt levels. We also like inflation-linked bonds.
Closing the gap
Yields on U.S. investment grade (IG) credit and short-term Treasuries, 1992-2023
Source: BlackRock Investment Institute, with data from LSEG Datastream, September 2023. Notes: The chart shows the yields for U.S. investment grade credit (using the Bloomberg U.S. Credit USD index) and short-term U.S. Treasuries (Bloomberg U.S. Treasury 1-3 Year USD index).
We believe the new regime of greater macro volatility calls for more nimble and dynamic strategic views. Short-term government bond yields have risen alongside long-term yields due to rapid central bank rate hikes. That move has pushed short-term U.S. Treasury yields (yellow line in the chart) near high quality credit yields (orange line), making short-term bond income comparable. We trim our overall underweight to developed market (DM) nominal government bonds to lean into short-term paper and reduce investment grade (IG) credit to underweight from neutral. We think high quality credit offers limited compensation for any potential hit to returns from wider spreads and sensitivity to interest rate swings. We prefer higher yields in private credit and see alternative lenders filling a corporate financing gap as banks curb lending.
Mega forces – structural shifts that can drive returns now and in the future – reinforce why we’re in a new regime of greater macro and market volatility, in our view. Aging DM populations could add to inflation as workforces shrink, keeping labor markets tight and wage growth high. And the rate of growth the economy will be able to sustain without stoking inflation will likely be lower than in the past. Aging also tends to come with elevated levels of government debt. We see the low carbon transition, another mega force we track, driving up energy costs over the next decade. A related capital spending surge and additional government spending will likely boost economic activity and bolster inflationary pressures. These and other mega forces underpin why we see central banks having a tightening bias to try to keep inflation near their policy targets.
Our view on long-term bonds
We went very underweight nominal government bonds in 2020 – but have trimmed that underweight at times when markets moved in line with our view. We trim it again but are not ready to turn positive on long-term bonds, even with the yield rise. That’s because term premium, or the compensation investors demand for the risk of holding long-term bonds, has risen from its lows but remains negative – especially for U.S. Treasuries, according to LSEG data. That is historically unusual.
We see three reasons long-term bond yields and term premium can climb higher: First, we believe markets will price in inflation settling above DM central bank 2% policy targets longer term. Second, we also see investors demanding more term premium to reflect greater risk in nominal bonds due to higher inflation volatility and rising debt levels. The U.S. credit rating downgrade last month underscored the fiscal challenges ahead. Third, foreign demand for long-term Treasuries may wane: For example, Japanese investors may switch to domestic bonds as yields climb from the Bank of Japan further lifting its cap on long-term yields. To turn positive on long-term bonds, we would need to see term premium rise much more or think market expectations of future policy rates are too high. We are not there yet.
We evolve our views with the August update of capital market assumptions and strategic portfolios. We up our allocation to short-term sovereign bonds, trim our overall underweight to nominal government bonds and cut IG credit to underweight. We stay underweight nominal government bonds overall due to the risks we see in long-term bonds. We favor inflation-linked bonds. And we like equities in the long term. Their returns should surpass fixed income returns when growth rebounds from the near-term stagnation we expect – even if it muddles along due to the demographic hit ahead.
U.S. stocks bounced back last week from a 2% drop in August as 10-year Treasury yields eased off a 16-year near 4.30%. The stock gains show just how sensitive market sentiment remains to yield moves and expectations for policy rates. The drop in July job openings and the August payrolls report indicated the U.S. labor market is now normalizing from pandemic mismatches. We see inflation on a rollercoaster ride ahead as normalization unfolds and an aging population starts to bite.
A slew of China data this week will help gauge fading economic momentum after a rapid post-Covid restart. China is facing two key challenges: weak consumer and export demand. We cut our growth expectation for this year to around 5% as a result. Two-year average growth over 2022-23 is set to be about 4%, much lower than the pre-Covid rate of roughly 5%.
China Caixin services PMI
U.S. ISM services PMI
China trade data
China total social financing; China CPI and PPI (Sept. 9)
Past performance is not a reliable indicator of current or future results. Indexes are unmanaged and do not account for fees. It is not possible to invest directly in an index. Sources: BlackRock Investment Institute, with data from Refinitiv Datastream as of Aug. 31, 2023. Notes: The two ends of the bars show the lowest and highest returns at any point in the last 12-months, and the dots represent current year-to-date returns. Emerging market (EM), high yield and global corporate investment grade (IG) returns are denominated in U.S. dollars, and the rest in local currencies. Indexes or prices used are: spot Brent crude, ICE U.S. Dollar Index (DXY), spot gold, MSCI Emerging Markets Index, MSCI Europe Index, Refinitiv Datastream 10-year benchmark government bond index (U.S., Germany and Italy), Bank of America Merrill Lynch Global High Yield Index, J.P. Morgan EMBI Index, Bank of America Merrill Lynch Global Broad Corporate Index and MSCI USA Index.
© 2023 BlackRock, Inc. All rights reserved.
General disclosure: This material is intended for information purposes only, and does not constitute investment advice, a recommendation or an offer or solicitation to purchase or sell any securities to any person in any jurisdiction in which an offer, solicitation, purchase or sale would be unlawful under the securities laws of such jurisdiction. The opinions expressed are as of September 05, 2023, and are subject to change without notice. Reliance upon information in this material is at the sole discretion of the reader. Investing involves risks.
In the U.S. and Canada, this material is intended for public distribution. In the European Economic Area (EEA): this is Issued by BlackRock (Netherlands) B.V. is authorised and regulated by the Netherlands Authority for the Financial Markets. Registered office Amstelplein 1, 1096 HA, Amsterdam, Tel: 020 – 549 5200, Tel: 31-20-549-5200. Trade Register No. 17068311 For your protection telephone calls are usually recorded. In the UK and Non-European Economic Area (EEA) countries: this is Issued by BlackRock Advisors (UK) Limited, which is authorised and regulated by the Financial Conduct Authority. Registered office: 12 Throgmorton Avenue, London, EC2N 2DL, Tel: +44 (0)20 7743 3000. Registered in England and Wales No. 00796793. For your protection, calls are usually recorded. Please refer to the Financial Conduct Authority website for a list of authorised activities conducted by BlackRock. In Switzerland, This document is marketing material. Until 31 December 2021, this document shall be exclusively made available to, and directed at, qualified investors as defined in the Swiss Collective Investment Schemes Act of 23 June 2006 (“CISA”), as amended. From 1 January 2022, this document shall be exclusively made available to, and directed at, qualified investors as defined in Article 10 (3) of the CISA of 23 June 2006, as amended, at the exclusion of qualified investors with an opting-out pursuant to Art. 5 (1) of the Swiss Federal Act on Financial Services ("FinSA"). For information on art. 8 / 9 Financial Services Act (FinSA) and on your client segmentation under art. 4 FinSA, please see the following website: www.blackrock.com/finsa For investors in Israel: BlackRock Investment Management (UK) Limited is not licensed under Israel’s Regulation of Investment Advice, Investment Marketing and Portfolio Management Law, 5755-1995 (the “Advice Law”), nor does it carry insurance thereunder. In South Africa, please be advised that BlackRock Investment Management (UK) Limited is an authorized financial services provider with the South African Financial Services Board, FSP No. 43288. In the DIFC this material can be distributed in and from the Dubai International Financial Centre (DIFC) by BlackRock Advisors (UK) Limited — Dubai Branch which is regulated by the Dubai Financial Services Authority (DFSA). This material is only directed at 'Professional Clients’ and no other person should rely upon the information contained within it. Blackrock Advisors (UK) Limited - Dubai Branch is a DIFC Foreign Recognised Company registered with the DIFC Registrar of Companies (DIFC Registered Number 546), with its office at Unit 06/07, Level 1, Al Fattan Currency House, DIFC, PO Box 506661, Dubai, UAE, and is regulated by the DFSA to engage in the regulated activities of ‘Advising on Financial Products’ and ‘Arranging Deals in Investments’ in or from the DIFC, both of which are limited to units in a collective investment fund (DFSA Reference Number F000738) In the Kingdom of Saudi Arabia, issued in the Kingdom of Saudi Arabia (KSA) by BlackRock Saudi Arabia (BSA), authorised and regulated by the Capital Market Authority (CMA), License No. 18-192-30. Registered under the laws of KSA. Registered office: 29th floor, Olaya Towers – Tower B, 3074 Prince Mohammed bin Abdulaziz St., Olaya District, Riyadh 12213 – 8022, KSA, Tel: +966 11 838 3600. The information contained within is intended strictly for Sophisticated Investors as defined in the CMA Implementing Regulations. Neither the CMA or any other authority or regulator located in KSA has approved this information. The information contained within, does not constitute and should not be construed as an offer of, invitation or proposal to make an offer for, recommendation to apply for or an opinion or guidance on a financial product, service and/or strategy. Any distribution, by whatever means, of the information within and related material to persons other than those referred to above is strictly prohibited. In the United Arab Emirates is only intended for - natural Qualified Investor as defined by the Securities and Commodities Authority (SCA) Chairman Decision No. 3/R.M. of 2017 concerning Promoting and Introducing Regulations. Neither the DFSA or any other authority or regulator located in the GCC or MENA region has approved this information. In the State of Kuwait, those who meet the description of a Professional Client as defined under the Kuwait Capital Markets Law and its Executive Bylaws. In the Sultanate of Oman, to sophisticated institutions who have experience in investing in local and international securities, are financially solvent and have knowledge of the risks associated with investing in securities. In Qatar, for distribution with pre-selected institutional investors or high net worth investors. In the Kingdom of Bahrain, to Central Bank of Bahrain (CBB) Category 1 or Category 2 licensed investment firms, CBB licensed banks or those who would meet the description of an Expert Investor or Accredited Investors as defined in the CBB Rulebook. The information contained in this document, does not constitute and should not be construed as an offer of, invitation, inducement or proposal to make an offer for, recommendation to apply for or an opinion or guidance on a financial product, service and/or strategy. In Singapore, this is issued by BlackRock (Singapore) Limited (Co. registration no. 200010143N). This advertisement or publication has not been reviewed by the Monetary Authority of Singapore. In Hong Kong, this material is issued by BlackRock Asset Management North Asia Limited and has not been reviewed by the Securities and Futures Commission of Hong Kong. In South Korea, this material is for distribution to the Qualified Professional Investors (as defined in the Financial Investment Services and Capital Market Act and its sub-regulations). In Taiwan, independently operated by BlackRock Investment Management (Taiwan) Limited. Address: 28F., No. 100, Songren Rd., Xinyi Dist., Taipei City 110, Taiwan. Tel: (02)23261600. In Japan, this is issued by BlackRock Japan. Co., Ltd. (Financial Instruments Business Operator: The Kanto Regional Financial Bureau. License No375, Association Memberships: Japan Investment Advisers Association, the Investment Trusts Association, Japan, Japan Securities Dealers Association, Type II Financial Instruments Firms Association.) For Professional Investors only (Professional Investor is defined in Financial Instruments and Exchange Act). In Australia, issued by BlackRock Investment Management (Australia) Limited ABN 13 006 165 975 AFSL 230 523 (BIMAL). The material provides general information only and does not take into account your individual objectives, financial situation, needs or circumstances. In China, this material may not be distributed to individuals resident in the People’s Republic of China (“PRC”, for such purposes, excluding Hong Kong, Macau and Taiwan) or entities registered in the PRC unless such parties have received all the required PRC government approvals to participate in any investment or receive any investment advisory or investment management services. For Other APAC Countries, this material is issued for Institutional Investors only (or professional/sophisticated /qualified investors, as such term may apply in local jurisdictions). In Latin America, no securities regulator within Latin America has confirmed the accuracy of any information contained herein. The provision of investment management and investment advisory services is a regulated activity in Mexico thus is subject to strict rules. For more information on the Investment Advisory Services offered by BlackRock Mexico please refer to the Investment Services Guide available at www.blackrock.com/mx
Not FDIC Insured | May Lose Value | No Bank Guarantee
© 2023 BlackRock, Inc. All Rights Reserved. BLACKROCK, iSHARES and ALADDIN are trademarks of BlackRock, Inc. or its subsidiaries in the United States and elsewhere. All other trademarks are those of their respective owners.