Jean Boivin – Head of BlackRock Investment Institute together with Wei Li – Global Chief Investment Strategist, Simon Blundell – Head of European Fundamental Fixed Income and Michel Dilmanian – Portfolio Strategist, all forming part of the BlackRock Investment Institute share their insights on global economy, markets and geopolitics. Their views are theirs alone and are not intended to be construed as investment advice.
Key Points
Changing risk perceptions: Investors now want more compensation for the risk of holding long-term bonds. We see this as a return to past norms and keep our long-held underweight.
Market backdrop : U.S. stocks rose nearly 2% last week, led by tech stocks. U.S. 10-year Treasury yields fell but are 50 basis points above their April lows.
Week ahead : U.S. jobs data this week will show how the labor market is holding up. The European Central Bank is set to cut policy rates as it eyes the impact of tariffs.
Long-term U.S. bond yields jumped from April lows as policy developments, like the budget bill, draw focus to U.S. debt sustainability. This has revived questions about the diversification role of Treasuries. We have long pointed to the low, even negative, risk premium investors accepted for Treasuries – and expected it to change. That’s now playing out, dragging up developed market government bond yields. We stay underweight long-term bonds but prefer the euro area to the U.S.
Ultra-low interest rates in the pandemic lulled investors into a sense of safety about ballooning government debt. They accepted lower term premium, or compensation for the risk of holding that debt over a long time. That pulled down global yields as well. See the chart. But long-term yields are up sharply since April as investors demand more term premium. We have long expected that. In 2021, we flagged that elevated government debt created a fragile equilibrium, with bonds vulnerable to changing investor perception of their risk. And we pointed to persistent inflation pressure from post-pandemic supply disruptions. Higher inflation, and thus higher policy rates along with any rise in term premium, boost debt servicing costs. We’re still underweight long-term developed market (DM) government bonds, but have a relative preference for the euro area and Japan over the U.S.
Our strongest conviction has been staying underweight long-term U.S. Treasuries. We maintain that view as concerns about the deficit mount. In March, we estimated the U.S. deficit-to-GDP ratio would land in the 5% to 7% range, based on external forecasts of the impact of proposed trade, fiscal and immigration policy. Since then, Moody’s cut the U.S. top-notch credit rating and Congress is considering a budget bill that we think could push deficits to the upper end of that range – or beyond. We’re watching to see if these changes impact foreign investors and drive term premium even higher.
Global yields rising
In Japan, 30-year bond yields hit a record high in May, confirming our long-standing underweight. Japan’s central bank – historically the largest government bond buyer as part of policy easing to lift the economy out of deflation – has trimmed purchases as part of its policy normalization. That has put pressure on long-term yields, and a recent long-term bond auction drew the weakest demand in a decade. This in turn prompted Japan’s Ministry of Finance to consider trimming long-term bond sales. If yields rise more, the government’s cost to service its debt – now twice the size of its economy – will also rise.
The UK is already rolling back long-term bond issuance amid lower demand and higher yields. Meanwhile, euro area yields have been rising as governments up defense and infrastructure investment. Yet we prefer euro area government bonds to the U.S. They’re increasingly less correlated to fluctuations in U.S. Treasuries, and a sluggish economy gives the European Central Bank more room to cut rates in the near term. For income, we prefer shorter-term government bonds and European credit – both investment grade and high-yield – over the U.S. on cheaper valuations.
On equities, we flipped back to being pro-risk in April once it became clear that hard economic rules limit how far U.S. policy can move from the status quo, such as how foreign investors fund U.S. debt. Our U.S. equity overweight relies on that rule, just as another rule – supply chains can’t rewire overnight without serious disruption – proved binding on trade policy. This overweight is grounded in the artificial intelligence mega force – reinforced by Nvidia’s earnings beat last week.
Our bottom line
U.S. Treasury yields have jumped since April. That’s a global story of normalizing term premium. We stay underweight long-term DM government bonds, preferring shorter-term bonds and euro area credit.
Market backdrop
U.S. stocks gained nearly 2% last week, led by tech stocks after Nvidia beat earnings expectations. The S&P 500 was up nearly 22% from its April lows. Stocks got a boost during the week after a U.S. trade court blocked most of the new U.S. tariffs. But a federal appeals court later granted a stay on the decision – allowing the tariffs to stay in place until a final decision is reached. U.S. 10-year Treasury yields edged down to 4.40% but are still 50 basis points above their April lows.
We’re watching this week’s U.S. payroll data for May after job gains topped expectations and wage growth cooled in April. We’re tracking the impact of trade disruptions on hiring and how slowing labor force growth affects wage pressures. We see the European Central Bank cutting policy rates modestly but look for signs that it might cut more deeply if trade disruptions weigh on euro area growth.
Week Ahead
June 3 : Flash euro area inflation; euro area unemployment data
June 5 : European Central Bank policy decision
June 6 : U.S. payrolls
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