Bonds suddenly get the love of recession-hedging investors

(Bloomberg) – Investors plagued by fear and avoidance of equities are rediscovering an age-old antidote: US government bonds.

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That might come as a surprise, given that the Treasury market has been battered by its worst losses on record this year. But with yields still at their highest in years, the Federal Reserve is on track to raise interest rates aggressively in the face of soaring inflation and collapsing growth overseas. , liquidity is returning as investors seek protection against downside risk to the economy. into a recession – dragging the stock market lower with it.

In April, as the S&P 500 entered its worst month since the Covid crash in March 2020, investors withdrew $27 billion from the largest equity-focused exchange-traded funds, according to data compiled by Bloomberg. At the same time, they invested $6 billion in comparable government bonds. The spread between the two hasn’t tipped all that much in favor of bonds since at least 2017.

“Fixed income has been unpopular, but yields are at their most attractive levels for some time,” said Chris Iggo, chief investment officer of core investments at AXA Investment Managers. He advised clients to build a “hedge against what could still be a bigger reaction in equity markets if growth starts to falter in 2023”.

The inflow into government bond funds comes after bouts of selling pushed yields back to more normal levels, giving investors a reason to buy again. The two-year Treasury bill rate hit nearly 2.8% on April 22 and ended Friday not far below that level. A year ago, when the Fed was still flooding the markets with liquidity, it was just 0.10%.

The magnitude and speed of this increase may mean that the market’s worst losses are behind it. Even though the US central bank is poised to continue raising interest rates – including at its May 4 meeting – policymakers will be careful not to derail the economic recovery. On Friday, traders expected the Fed’s target rate to peak at around 3.35% next year, well below where it ended every modern hike cycle until 2018.

“In a scenario where the Fed does even more than that, the market is likely to assume an even bigger slowdown in growth, which means rates won’t necessarily rise much more,” said strategist Andrew Sheets. multi-asset chief of Morgan Stanley. in an interview.

This, indeed, can help limit the magnitude of bond returns. Yields rose across the board on Friday after a spike in employment costs stoked inflation concerns. But they remain below the peaks observed in April.

“There has been a strong revaluation of bonds,” said Pascal Blanque, president of the Amundi Institute, in an interview. “It should remain on pause or even pull back as the central bank delivers less than needed, feared or valued in the market. This makes US fixed income attractive again.

Amundi is among those taking a less bearish stance on government bonds, along with Jefferies International and Morgan Stanley. While few are enthusiastic bulls, there is less outright debt aversion, in part because higher yields have changed the calculus. At nearly 3%, for example, the 10-year Treasury yield has outpaced the S&P 500’s 12-month forward dividend the most since 2011.

BlackRock Inc. has been warning since December that bonds are heading for a second straight year of losses in 2022. But Laura Cooper, senior investment strategist at BlackRock, said bonds could start to look more attractive as protection against losses in d other corners of the financial markets.

“We ask the question, are bonds now a hedge for risky assets in portfolios?” Cooper said in an interview with Bloomberg TV this week. “We haven’t really seen that in the last two years thanks to Covid. Are yields sufficiently attractive at the current level? Maybe not yet. But it’s definitely something we’re watching.

The shift to bonds and equities underscores growing doubts about the Fed’s ability to avoid triggering a recession. In the early 1980s, the last time inflation was as high as it is today, tightening monetary policy by the Fed led to severe economic contractions. The recessions that started in 1990, 2001 and 2007 all followed Fed rate hikes as well.

“This is a flight to safety trading, as it is one of the most aggressive rotations in government bond ETFs we have seen,” said ETF analyst Athanasios Psarofagis. at Bloomberg Intelligence. “Equity ETFs don’t historically see outflows, which says a lot about the bearish sentiment in the market right now.”

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