Amid attractive yields, BlackRock is increasing its allocation to short-term sovereign bonds, while it remains cautious on long-term bonds, even with the rise in yields.
“Sovereign bond yields have surged this year, with US long-term yields hitting 16-year highs last month,” said Jean Boivin, head of the BlackRock Investment Institute. “We prefer short-term government bonds over credit.”
At the same time, the US fund house is trimming its overall underweight to nominal government bonds and cutting investment-grade (IG) credit to underweight.
“We stay underweight nominal government bonds overall due to the risks we see in long-term bonds,” added Boivin.
Being more agile
BlackRock’s approach to managing portfolios in today’s new regime of greater macro volatility is nimbler and more dynamic strategic views.
“Short-term government bond yields have risen alongside long-term yields due to rapid central bank rate hikes,” Boivin explained. “That move has pushed short-term US Treasury yields near high quality credit yields, making short-term bond income comparable.”
In line with this view, trimming its overall underweight to developed market (DM) nominal government bonds enables the firm to lean into short-term paper and reduce 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,” said Boivin.
Meanwhile, BlackRock prefers higher yields in private credit and sees alternative lenders filling a corporate financing gap as banks curb lending.
Higher yields longer term
According to Boivin, there are three reasons long-term bond yields and term premium can climb higher.
The first is based on the view that markets will price in inflation settling above DM central bank 2% policy targets longer term.
In addition, BlackRock sees investors demanding more term premium to reflect greater risk in nominal bonds due to higher inflation volatility and rising debt levels. “The US credit rating downgrade last month underscored the fiscal challenges ahead,” added Boivin.
Further, he believes 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.”
However, to turn positive on long-term bonds, Boivin said there would need to be a much bigger rise in term premium, or a strong view that market expectations of future policy rates are too high. “We are not there yet,” he added.