There are a series of factors that are driving the current rally in the US bond markets though the main one that has been apparent for a long time and driving the market is the incredible amount of liquidity, said Rick Reider, co-head of America’s fixed income at BlackRock Inc.
Some of the reasons include a rush to safety due to geopolitical tensions in Russia and the Fed advancing gradually with tightening, because America’s economic data points are going to improve slowly. However, the most significant reason is, and investors often tend to miss it, the yield difference between US Treasuries and German and Japanese 10-year govt. bonds. US Treasuries at about 2.5 percent look attractive compared with Germany’s 1.4 percent or Japan’s 1.6 percent. Given the amount of liquidity in the market, owning some duration is actually good, he explained.
Asked how long the relative value could persist, Rick said the dynamic currently at play is not only extraordinary, but truly historic. There is a situation where European Central Bank President Mario Draghi is going to be extraordinarily aggressive, which is going to drive into bond yield spreads; and then there is an aggressive Bank of Japan which could potentially be more aggressive going forward. As long as those stimuli are in place, Treasuries could drift higher and the yield volatility could be profound, he said.
Asked if ECB President Mario Draghi is going to stare down the Bundesbank, because this time it’s different, Rick said everything that the Bundesbank has described publically indicates they understand that there is more fireworks that has to go (into fighting the slowdown).
Asked to explain how fixed-income analysts are playing the market now, Rick said investors need to understand the macro-economic picture first. Mario Draghi is most probably going to go down the road of negative deposit rates, and ultimately he’s going to talk about other forms of loose quantitative easing, asset-backed purchases, etc. He’s going to try to drive the yields down though some of the peripheral debts of Spain and Italy could still make sense. Bank capital is also an attractive place to play because euro-area bank recapitalizations are going to take place soon, he noted.
Asked to comment on US Treasury yields, Rick said US 10-year yields are going to drift higher as economic growth improves. They are likely to hit three percent annual rate though it could stay at a pretty low range for a long, long time, he observed.
Asked if investors should stop worrying about inflation now, Rick said monetary policies of the world indicate people are more worried about deflation than inflation though that doesn’t mean there would be no inflationary conditions in the longer term. But with the Chinese economy slowing down and weak inflationary conditions in Japan, there is a near-term risk of inflation deceleration. However, in some parts of the economy, particularly in the short-term unemployment area, there are small wage pressures, he added.
Asked if the current Portuguese 10-year yield at 3.83 percent was too low, Rick said Draghi has been holding down peripheral yields relatively well. Because of their falling yields, which failed to reflect the true systemic risks, BlackRock exited some of the peripheral markets. Italy was great value at seven percent while Portugal was great value at 7/8/9 percent earlier. Compared with their yields now, US Treasuries at 2.43 percent does not look that bad, he concluded.
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