Wei Li – Global Chief Investment Strategist of BlackRock Investment Institute together with Vivek Paul – Global Head of Portfolio Research, Michel Dilmanian – Portfolio Strategist and Beata Harasim – Senior Investment 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
Our strategy for rising yields: Yields have surged across fixed income in the new regime. In Q2, we stay nimble and selective, preferring short-term sovereign bonds and high yield credit.
Market backdrop: The S&P 500 jumped 10% in Q1 even as bond yields rose on markets pricing out rate cuts. In Japan, the yen slid to a 34-year low against the U.S. dollar.
Week ahead: We eye this week’s U.S. payrolls data to see if rising immigration will keep boosting job gains, offsetting for now an aging population and workforce.
Yields jumped as central banks hiked rates to historic highs – ushering in a new era for fixed income. We see higher yields persisting even if rate cuts are coming. We think central banks will keep rates higher for longer than pre-pandemic due to persistent supply constraints. While income is back, tight U.S. credit spreads and long-term yield volatility pose risks. To kick off Q2, we stay selective in fixed income and credit. We favor hard currency emerging market debt and high yield credit.
For a decade, negative yielding bonds flooded global markets as central banks slashed rates and bought bonds to loosen policy, surging to above $18 trillion at its peak in a key global bond index. See the chart. Negative yields are now history – a massive shift for fixed income markets. Yields hit multi-decade highs after central banks hiked rates to rein in inflation after the pandemic, with U.S. 10-year yields hitting 16-year highs last year. We had expected long-term yields to surge – staying underweight for a few years on both tactical and long-term horizons until turning neutral tactically last year. We think interest rates will stay higher for longer as inflation proves sticky, limiting how far central banks cut rates. Higher rates mean bonds provide more income cushion. Yet greater macro volatility has hampered their ability to offset risk asset selloffs. That’s why we stay selective in fixed income.
We get selective on a six- to 12-month tactical horizon given ongoing volatility in long-term bond yields and tightening U.S. credit spreads. We’re neutral high yield credit and find that overall yields for the riskier asset class are more attractive than for investment grade (IG) credit, where spreads have tightened more on a relative basis. Returns for high yield credit are also less sensitive to elevated interest rate volatility. While default rates have risen since 2022, they seem to be stabilizing, Moody’s data show. We prefer euro area high yield where spreads have not tightened as much relative to the U.S. Our risk-on stance in this environment underpins our preference for high yield credit over IG, and is more supportive of stocks over bonds. Yet IG credit may be attractive for investors solely focused on fixed income, as we don’t expect spreads to widen notably this year.
Getting granular across horizons
We stay nimble and granular on a regional level in our other views, too. For example, we favor emerging market (EM) hard currency debt – largely issued in U.S. dollars – over developed market government bonds. EM hard currency debt spreads have also not tightened as much as overall euro area and U.S. credit spreads. And we see a near-term macro backdrop that is more supportive of risk-taking, with some EM central banks cutting rates as inflation cools. On inflation-linked bonds, we had preferred the U.S. Now, we up euro area inflation-linked bonds to neutral as market inflation expectations fall as we expected.
How do our views differ on a strategic horizon of five years and longer? We are overweight developed market inflation-linked bonds due to persistent inflation pressures – and prefer them over long-term government bonds. We stick with our tactical and strategic preference for short-term bonds. We see long-term yields rising as investors demand more compensation for the risk of holding long-term bonds given record debt loads and ballooning bond supply. On credit, we prefer private over public. We see greater demand for private credit as banks pull back on lending and yields better compensate for risk than public credit. Private markets are complex, with high risk and volatility, and aren’t suitable for all investors.
Our bottom line
Higher interest rates in the have spurred a new era in the fixed income landscape. We stay selective in the Q2 update of our tactical views. We prefer short-term government bonds, euro area high yield credit and EM hard currency debt.
Market backdrop
The S&P 500 closed out Q1 at a new record high last week. The index jumped 10% in Q1 even as bond yields rose on markets pricing out rate cuts. The U.S. 10-year Treasury yield was mostly flat to finish near 4.20%. Japanese equities receded from record highs as the yen slid to a 34-year low against the U.S. dollar. Yields on Japanese 10-year government bonds dipped further after the Bank of Japan’s end to negative rates last month was about normalizing policy, not anxiety over inflation.
We keep a close eye on the U.S. payroll report out this week to gauge if job gains can keep growing sharply due to elevated migration. Longer term, we think the U.S. could face the risk of structurally slower labor force growth – a key production constraint – as its population ages and without a further boost from migration.
Week Ahead
April 2: U.S. job openings and labor turnover data
April 3: Euro area flash inflation data and unemployment; China Caixin services PMI
April 4: U.S. trade data
April 5: U.S. payrolls
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