Why to be wary of these bonds

We see Federal Reserve rate increase expectations returning as a bond market driver, justifying our cautious stance on sovereign debt. Richard explains, with the help of this week’s chart.

Geopolitical forces suppressing global government bond yields have somewhat dissipated after the first round vote of the French presidential election. We see Federal Reserve (Fed) rate increase expectations returning as a bond market driver, justifying our cautious stance on sovereign debt.

The business-friendly Emmanuel Macron’s clear first-round election win in France reduced near-term European political risk. Markets are now pricing in nearly 1.5 additional 0.25% rate increases in the U.S. this year, but we think they still underestimate the Fed’s resolve to tighten policy.

Focus returns to the Fed

The Fed has made clear it views the U.S. economy as nearing the central bank’s employment and inflation goals and accordingly plans to stay on a gradual normalization path. We expect global government bond yields to rise—and prices to fall—as market expectations catch up to our base case of two more Fed rate increases this year.

Strong demand for income and still-accommodative central bank policies in much of the world should help keep rises in yields moderate, in our view. We do expect to see a steepening of the yield curve over time, where very long-term bond yields rise faster than those on shorter-term bonds. This is because we see reflation moving from a period of accelerating growth to a new phase of sustained economic expansion.

We see yields on bonds with durations of five years or less (i.e., the short end of the yield curve) as vulnerable in the near term to any jumps in Fed tightening expectations, and we are underweight U.S. Treasuries and European sovereign bonds overall. Bullish sentiment following the French vote sparked the selling of safe-haven assets. Rising European growth and inflation, along with the prospect of a less supportive European Central Bank, may help push European and global yields higher. We expect the Bank of Japan to stay on hold until we see meaningful Japanese growth and inflation. Read more market insights in my Weekly Commentary.

Richard Turnill is BlackRock’s global chief investment strategist. He is a regular contributor to The Blog.

 

 

Investing involves risks, including possible loss of principal. Fixed income risks include interest-rate and credit risk. Typically, when interest rates rise, there is a corresponding decline in bond values. Credit risk refers to the possibility that the bond issuer will not be able to make principal and interest payments.

This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of May 2017 and may change as subsequent conditions vary. The information and opinions contained in this post are derived from proprietary and nonproprietary sources deemed by BlackRock to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by BlackRock, its officers, employees or agents. This post may contain “forward-looking” information that is not purely historical in nature. Such information may include, among other things, projections and forecasts. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this post is at the sole discretion of the reader.

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