The Force Driving Yields Down

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Key points

  • We upgraded our short-term view on U.S. Treasuries amid looming risks and dovish expectations for central bank policy.
  • The Federal Reserve (Fed) stood pat on rates, and its cautious stance points to continued easy global monetary policy.
  • The U.K. Brexit vote will dominate sentiment this week, with polls pointing to a marginal lead for the "leave" camp.

Risk aversion ahead of the U.K. vote on whether to leave the European Union (EU), along with easy central bank policies, is pushing global bond yields to ever-lower levels and pausing the "divergence" trend that has been driving global yields for two years.

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The Fed affirmed a dovish stance by keeping U.S. rates on hold and pointing to a shallower path of rate hikes ahead. In Europe, sustained European Central Bank (ECB) bond buying is driving down bond yields. No change came out of the Bank of Japan's (BoJ's) meeting, though expectations of further non-traditional measures are high. The net result of this synchronized caution: a drop in short-term yields globally, as shown in the chart above.

Surviving the low-rate epidemic

Brexit-induced risk aversion and easy central bank policy have global bond yields sinking. Ten-year U.S. Treasuries are approaching lows of 2012 and Germany has joined Japan with negative 10-year yields.

The Fed is balancing sustained consumption growth and rising inflation pressures against global growth risks and slowing jobs growth. The latter is winning the battle for now. We expect one or perhaps two Fed rate increases this year.

In the eurozone, we expect no imminent change in ECB policy, but could see an extension of quantitative easing and bubbles in interest-rate-sensitive assets. Emphasis in Europe and elsewhere needs to shift to fiscal policy and reform, we believe. In Japan, the BoJ will likely ease further in July or September, and could intervene earlier to stabilize the yen in the event of a Brexit outcome.

We have upgraded U.S. Treasuries and fixed income overall to neutral, and remain cautious on risk assets pending the U.K. vote. Negative rates outside the U.S. are increasing demand for longer-dated Treasuries. We prefer Treasury Inflation-Protected Securities over nominal Treasuries. Slowing policy divergence should limit upward pressure on the dollar. We like gold as a diversifier.

  • Brexit fears stoked acute risk-off activity. ETF flows show European equities lost $851 million and high yield $1.96 billion, as gold took in nearly $1 billion in the five days ended June 16.
  • Volatility surged and Japan led global markets down with the sharpest weekly fall since February. The yen touched its strongest level versus the dollar since August 2014.
  • The Fed's no-hike decision was accompanied by downgraded expectations for the pace of rate normalization in 2017 and 2018.

Global snapshot

Weekly and 12-Month performance of selected assets

Equities Week YTD 12 Months Div. Yield
U.S. Large Caps -1.2% 1.3% -1.4% 2.2%
U.S. Small Caps -1.6% 1.5% -8.4% 1.5%
Non-U.S. World -2.6% -2.5% -12.2% 3.4%
Non-U.S. Developed -2.8% -5.3% -11.8% 3.6%
Japan -3.4% -6.6% -8.8% 2.6%
Emerging -2.1% 2.4% -14.8% 2.8%
Asia Ex Japan -2.4% -1.1% -14.7% 2.8%
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Bonds Week YTD 12 Months Yield
U.S. Treasuries 0.2% 4.5% 5.4% 1.6%
U.S. TIPS -0.4% 5.1% 3.0% 1.6%
U.S. Investment Grade -0.2% 6.6% 6.5% 3.0%
U.S. High Yield -0.8% 8.3% 0.5% 7.4%
U.S. Municipals 0.4% 3.9% 7.3% 1.7%
Non-U.S. Developed 0.5% 11.4% 10.9% 0.6%
Emerging Market $ Bonds -0.4% 8.0% 8.2% 5.7%
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Commodities Week YTD 12 Months Level
Brent Crude Oil -2.7% 31.9% -23.0% $49.17
Gold 1.9% 22.4% 9.5% $1,299
Copper 0.9% -3.3% -20.8% $4,552
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Currencies Week YTD 12 Months Level
Euro/USD 0.2% 3.8% -0.5% 1.13
USD/Yen -2.6% -13.4% -15.6% 104.16
Pound/USD 0.7% -2.6% -9.3 1.44
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Source: Bloomberg. As of June 17, 2016.
Notes: Weekly data through Friday. Equity and bond performance are measured in total index returns in U.S. dollars. U.S. large caps are represented by the S&P 500 Index; U.S. small caps are represented by the Russell 2000 Index; Non-U.S. world equity by the MSCI ACWI ex U.S.; non-U.S. developed equity by the MSCI EAFE Index; Japan, Emerging and Asia ex-Japan by their respective MSCI Indexes; U.S. Treasuries by the Barclays U.S. Treasury Index; U.S. TIPS by the U.S. Treasury Inflation Notes Total Return Index; U.S. investment grade by the Barclays U.S. Corporate Index; U.S. high yield by the Barclays U.S. Corporate High Yield 2% Issuer Capped Index, U.S. municipals by the Barclays Municipal Bond Index; non-U.S. developed bonds by the Barclays Global Aggregate ex USD; and emerging market $ bonds by the JP Morgan EMBI Global Diversified Index. Brent crude oil prices are in U.S. dollars per barrel,gold prices are in U.S. dollar per troy ounce and copper prices are in U.S. dollar per metric ton. The Euro/USD level is represented by U.S. dollar per euro, USD/JPY by yen per U.S. dollar and Pound/USD by U.S. dollar per pound. Index performance is shown for illustrative purposes only. It is not possible to invest directly in an index. Past performance is not indicative of future results.

Asset class views

Views from a U.S. dollar perspective over a three-month horizon

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This post originally appeared on the BlackRock Blog.