Bonds: Treasuries
Last month, investors must have spent more than a little time at their neighborhood ATM. After all, during that period, they poured $62.1 billion into ETFs, according to zacks.com.
That’s setting some pace, at that, considering it’s almost tripled February inflows, according to the BlackRock report. The first quarter net inflows as a result: $148.5 billion.
Fixed income ETFs fueled most of the inflows. Marking the largest gain since October, it hauled in approximately $38 billion.
Meantime, the Innovator, an outcome-based ETF issuer, recently was more than a little busy. It launched a unique suite of barrier ETFs that extends protection by scooping up U.S. Treasurys and selling equity options, according to cnbc.com.
“Advisors are realizing that bonds aren’t the safe haven that many thought they would be,” the firm’s CIO, Graham Day, told CNBC’s “ETF Edge.” “If you can pair [a barrier ETF] with the fixed income, it offers a tremendous amount of diversification benefits.”
And talk about two birds with one stone. These ETFs nip credit risk in the bud and yield liquidity every day, Day explained.
Bond volatility continued to explode last week due to growing contagion fears from U.S. banks. Last Monday, after a weekend in which the U.S. government intervened to protect depositors of Silicon Valley Bank and Signature Bank, the 2-year U.S. note yield experienced its biggest one-day fall since October 20th, 1987. Outside of U.S. hours, it dropped the most since 1982. That intraday drop of close to 60 basis points even exceeded the declines during the 2007-2009 financial crisis, the September 11th, 2001, terrorist attacks, and 1987’s Black Monday market crash. Gregory Staples, head of fixed income North America at DWS Group in New York told MarketWatch that the week’s decline in the 2-year U.S. yield came as the result of “de-risking of portfolios and draining of liquidity, stemming from concerns about the health of the U.S. banking system, exacerbated by questions about the future of Credit Suisse.” The ICE BofAML Move Index, which measures bond-market volatility, surged on Wednesday and Thursday to its highest levels since the fourth quarter of 2008, during the height of the Financial Crisis. Volatility then continued on Friday over concerns around First Republic Bank. This sent Treasury yields plunging, one day after they spiked on the news of a funding deal.
Finsum:Last week, the ICE BofAML Move Index, a measure of bond-market volatility, soared to its highest levels since the 2008 Financial Crisis as banking concerns continue.
Over the past two weeks, Treasuries have been considered a safe haven for investors amid the current turmoil in the banking system. While Monday offered a quick respite as investors learned of the news that UBS is rescuing Credit Suisse in a $3.24 billion deal, yields are expected to move lower in the days and weeks ahead if the turmoil continues. Kelsey Berro, a portfolio manager in J.P. Morgan Asset Management’s global fixed-income group told Barron’s that “The direction for Treasury yields should be lower." She added that “This month’s bank-related volatility shows that high-quality bonds are working as a portfolio diversifier this year.” Rick Bensignor, managing partner of Bensignor Investment Strategies concurs. He told Barron’s that he thinks Treasury prices will go higher, pushing yields lower. He says that he “Can see the 10-year Treasury’s yield falling to 3.2% or even 3.1%, compared with 3.48% on Monday afternoon.” Bensignor expects that “There will be more banks that are going to let us know how much trouble they are in. It’s going to force people into the safety of the bond market.”
Finsum:While Monday offered a brief respite, treasuries yields are expected to move lower if the upheaval in the banking system continues, according to bond strategists.
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When stocks are down like they were last year, investors usually look towards treasuries for safety. But last year was unlike any other year. While the S&P 500 fell 18%, the Bloomberg U.S. Aggregate Bond index slumped 13%. However, a year like 2022 is unlikely to happen again any time soon. According to analysts, that leaves “room for those bonds to reclaim their role as a core risk-off allocation for asset owners this year.” For example, when SVB Financial Group recently announced hefty losses, the S&P 500 index fell 3.4% between March 8th and March 13th. But investors looking for a safe haven in long-dated Treasuries sent yields plunging, providing bondholders with a gain of more than 4%. Many analysts expect the conditions that led to close correlations between the stock and bond market “to prove ephemeral.” According to Jason Vaillancourt, global macro strategist with Putnam Investments, the biggest risk for those strong correlations is when "The Fed gets really fired up to fight inflation, as with the central bank's 'uh-oh' moment last year — when inflationary pressures it had deemed transitory proved anything but, forcing the central bank to shift aggressively to catch-up mode.” He added, “With the Fed frontloading its fight against inflation last year, the conditions required to maintain correlations at 1 this year are unlikely to persist.”
Finsum:With the Fed front-loading its fight against inflation last year, the conditions that led to a high correlation between the stock and bonds markets, aren’t likely to persist.
Even though inflation continues to force the Fed’s hand on tightening, money managers are starting to rebuild their exposures toward Treasuries, with the hope that the highest payouts in years will help cushion portfolios from the damage inflicted by additional rate hikes. For instance, Morgan Stanley believes that a multi-asset income fund can find some of the best opportunities in decades in dollar-denominated securities such as inflation-linked debt and high-grade corporate obligations. That’s because interest payments on 10-year Treasuries have hit 4.125%, the highest since the financial crisis. In addition, PIMCO estimates that long-dated securities, which have been hit hard due to the Fed’s hawkishness, will bounce back if a recession should occur. They believe that a recession would ignite the bond-safety trade, where government debt would act as a hedge in the much-maligned 60/40 portfolio. Essentially, higher income and lower duration are helping to make the case that bonds will have a much better 2022. While inflation and liquidity concerns remain, the median in a recent Bloomberg survey shows “dealers, strategists and economists project bond prices will rise modestly in tandem with cooling inflation, with the 10-year US note trading at 3.5% by end of next year.”
Finsum:A combination of higher income payments and lower duration has money managers becoming more bullish on treasuries.
Much has been written about the failure of the 60/40 portfolio this year. What was once the classic allocation has seen its share of losses in 2022. Fueled by drawdowns in both the equity and fixed-income markets, advisors and investors are now thinking twice about the following a 60% allocation in stocks and a 40% allocation in bonds. However, there could be a fix. According to fixed income specialist David Norris, the 60/40 portfolio split should be flipped and focused on short-term bonds. Norris, head of U.S. Credit at TwentyFour Asset Management, told Financial Advisor Magazine that “the bond side of that reversal should be anchored in short-duration bonds.” Norris said that “the rate cycle we are in now, with a lot of volatility and inflation, has created a fixed income market with rates we have not seen for a decade. Yields for short-duration bonds are very attractive now.” Norris is not wrong; U.S. short-term government bonds are paying more than 4.5% right now. A focus on short-term bonds should help investors better navigate the current volatility in the market.
Finsum:A bond strategist at TwentyFour Asset Management believes that the 60/40 portfolio should be flipped and focused on short-term bonds.