Global bond fund managers are going long duration on US Treasuries. Several interviewed by AsianInvestor said they are allocating more to US 10-year Treasury bonds or those of longer duration.
Financial market volatility in equities, oil and currencies has forced a return to risk-off positions and emphasising the importance of liquidity. But fears over the US economy make medium-term exposures to Treasuries unattractive.
“We are going long the long end of the yield curve,” said Thomas Poullaouec, Asia head of strategy and research at State Street Global Advisors. “We are also overweight cash and overweight the US [fixed-income markets versus the rest of the world].”
Liquidity is a concern at a time when sovereign wealth funds and monetary authorities in Asia and the Middle East are selling their holdings of Treasuries to support their own currencies.
“We’re a little worried about sovereign wealth funds selling their holdings of US Treasuries for liquidity purposes,” said Malie Conway, co-chief investment officer at Rogge Global Partners in London. “The US 10-year Treasury still seems to be at fair value.”
Liquidity is of particular concern in the lower-quality areas of fixed income. For example, Western Asset is avoiding high-yield bonds, even if valuations are now attractive due to widespread selling of certain issuers, such as oil-and-gas companies.
“We can’t always hold these securities to maturity because our clients are redeeming,” said Desmond Soon, head of Asia ex-Japan fixed income at Western Asset in Singapore. “The pricing may be attractive, but if you end up having to sell, there may be no bid.”
In this environment, noted Soon, most investors are fleeing to the perceived safety of long-term US Treasuries, which is reflecting in the falling yields on 30-year bonds. (Bond yields fall as their prices rise.) “We are long duration,” he said, with the expectation that the yield curve will flatten.
The US Federal Reserve’s stated intent is to raise short-term interest rates four times in 2016, perhaps by 25 basis points each time, but market players are skeptical it can meet this. The Fed is constrained by several factors: a strong dollar, which hurts US corporate earnings abroad as well as American exporters; market volatility, such as that of Chinese stocks or commodities such as oil; and the fear of tipping a fragile US economy back into recession.
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Yet not everyone believes that long-dated US government bonds are the best place to be.
Jerome Booth, head of New Sparta Asset Management in London, is a longstanding enthusiast of emerging markets. He argues that mainstream investors from the West are blind to the long-term problems of heavy indebtedness in Europe and North America.
“There is no way that inflation is being priced into long-term bonds,” he said. “Which is crazy, given the amount of money that has been printed,” by central banks, including the Fed.
Booth argues that investors are wrong to flee emerging markets as they are inherently more stable than heavily indebted Western countries. He attacked the prevailing wisdom that US Treasuries represent ‘risk-free’ exposure.
Voices such as his are lonely ones, however. Nor is it just global investors that have pulled $735 billion from emerging markets last year, as estimated by the Institute of International Finance. It said $676 billion of that amount was withdrawn by China.
The low level of foreign exposure to China means the vast bulk of EM outflows are being made by the Chinese themselves, fleeing a weakening renminbi, various government clampdowns or other domestic troubles.
During times of ‘flights to quality’, the only conventional safe zone is the US Treasury market. SSGA’s Poullaouec said tenors in the three-year and five-year range are unattractive now. One-year yields or shorter-term paper is valued for its liquidity. But the US 10 year boasts the most attractive yields of all G10 issuers, bar Australia. Australia’s 10-year yields around 2.7% while the US 10-year yield is around 2% and European and Japanese yields are low or, in the case of Switzerland, negative.
Last week, the US 10-year yield fell to 1.98%, its lowest level in three months. This reflects heavy buying by investors seeking shelter and is contributing to continued dollar strength against other currencies.
Some investors also tout high-quality corporate bonds. Western’s Soon said medium-tenor issues by top-rated companies have seen spreads widen more than is warranted.
Rogge’s Conway said she was also "slightly" long bonds of short duration issued by utilities and other entities that offer plenty of visibility on future earnings. She said short-duration European commercial mortgage-backed securities also offered value.