According to BlackRock, the world’s largest asset manager, a major part of the recession’s playbook is “outdated” – and that’s finding shelter in bonds. “Recession fears are confusing markets. Investors traditionally hide in sovereign bonds, but we consider this recession playbook to be obsolete,” wrote strategists at the BlackRock Investment Institute, led by Jean Boivin, in a note earlier this year. week. Central banks raised interest rates to control inflation, “causing recessions” in the process. But they didn’t cut rates as they typically do in a recession due to lingering inflation, BlackRock said. Additionally, BlackRock expects investors to “demand more compensation for the risk of owning government bonds in a high-leverage environment.” That’s why the firm believes that treasury bills are less attractive right now. “We are underweight government bonds because yields have room to rise, and we don’t believe they can be a safe haven in a recession,” BlackRock wrote. Bond yields move inversely to prices. Interest rates would need to hold steady or fall for Treasury yields to turn positive, the company added. ‘Bonds are back’ Long-term yields are rising in developing markets due to tighter monetary policy, inflation and debt, BlackRock said. “Central banks in the new regime face a sharper trade-off between growth and inflation than in the past,” the firm’s strategists wrote. “We think central banks will eventually halt rate hikes. But they won’t have done enough to bring inflation back to target, which means they won’t be able to start easing policy, in our opinion.” Rising rates and inflation will create a “ripe environment” for investors to demand higher term premiums for long-term bonds, BlackRock said. A term premium is the amount by which the yield on a long-term bond exceeds the yield on shorter-term bonds, reflecting the amount investors expect to be compensated for lending over longer periods. . “All of this underscores why the old recession safety playbook doesn’t apply,” the company wrote. “It’s not just a reflection: we see him play in the UK in real time.” BlackRock cited the recent crisis in the UK and its subsequent central bank bond-buying plan. The UK government announced a sweeping economic plan – a so-called ‘mini-budget’ that included unfunded tax cuts – on September 23. The move sent financial markets into a tailspin as investors dumped UK bonds and sold the pound. In a bid to stem the sell-off, the Bank of England announced in late September that it would delay its plan to sell UK government bonds and buy long-term bonds for two weeks as part of emergency measures to calm the market. The bond-buying program ended last week, but yields rose again afterward, BlackRock noted. The sell-off may not subside, with the return of “bond vigilantes”, the asset manager said. The term refers to bond traders who threaten or actually sell a large amount of bonds to signal their protest to the issuer. “In this environment, bond vigilantes are back and heralding the return of the term premium,” BlackRock said. “The result: we are significantly underweight government bonds. US bond yields are the most positively correlated to equities in two decades on a 90-day rolling basis. We expect this correlation to remain positive, erasing the role of bonds as portfolio diversifiers,” he added. Additionally, rising short-term bond yields make long-term bonds less attractive, as investors can earn decent returns for the former with less interest rate risk, the company added. Yields on 2-year US Treasuries have surged recently, along with rate hikes by the US Federal Reserve. It has since remained high at 4.45%. What to buy Investors still looking to buy bonds should prefer inflation-linked bonds because they “don’t take into account persistent inflation,” BlackRock said. The asset manager also likes high-quality credit – strong corporate balance sheets should limit default risks even in a recession, he said.
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