BlackRock has taken a broadly underweight position in government bonds, instead backing high quality credit, as the prospect of a rate hike-induced recession looms.
In a research note, the buy-side heavyweight predicted long-term yields to rise across developed markets on the back of central bank policy, inflation and debt. Central bank policy is likely to trigger recessions but banks hands are tied due to persistent inflation, it added.
Using the example of the UK markets, BlackRock said the “old recession safe-haven” of taking cover in sovereign bonds was “obsolete” leading to its decision to remain underweight in Treasuries for the time being.
“Higher policy rates and inflation create a ripe environment for investors to demand higher term premia for long-term bonds,” it said. “In this environment, bond vigilantes are back and heralding term premium’s return.”
The asset manager has taken a broadly underweight position in virtually all government bonds as a result, including in the US.
It predicted that positive correlation of US bond returns to actual stocks – the closest they’ve been in two decades on a 90-day rolling basis – would continue, adding that this erases the role of bonds as portfolio diversifiers. Elsewhere it argued that current long-term yields did not reflect the persistence of inflation and that higher short-term rates meant investors could get better returns from short-dated bonds with less interest rate risk.
The firm cut UK gilts to underweight on the back of fiscal credibility concerns previously and also remains neutral on euro bonds thanks to a “too hawkish” approach to European Central Bank rate hikes.
However, it has chosen to go underweight on Italian bonds thanks to the shared “vulnerabilities” it has with the UK, namely its heavy debt burden and current account deficit.
“Strategically, we’re underweight developed market government bonds and see yields higher in five years and beyond,” BlackRock said. “We prefer inflation-linked bonds both tactically and strategically given they are not pricing in persistent inflation. We like high quality credit: Strong corporate balance sheets should limit default risks even in a recession, in our view.”