Investors are flocking to the
short-end of the bond market as money managers declare it one of the safest
spots to shelter from the Federal Reserve’s continued tightening of monetary
policy and the jitters that have contributed to an October stock-market rout.
Bond fund managers, including the
likes of Pimco and BlackRock, have urged turmoil-weary investors to seek
shelter in short maturity bonds as higher interest rates push front-end yields
to more attractive levels. That has helped dent the argument behind TINA—an
acronym for the “there is no alternative”—the mantra that held that investors
have few alternatives to stocks in a low interest rate universe.
Short-dated bonds are unlikely to
match the returns of equities, but in a year where market turmoil has left few
investments unscathed, it may end up as one of the few positive-yielding assets
this year. Analysts say current yields for shorter maturity bonds leave them
well-placed to protect investors from higher interest rates and stock market
weakness.
“The fact that you’re in the
front-end of the yield curve means you either benefit from unrealized gains, or
some higher reinvestment opportunities,” said Eric Souza, senior portfolio
manager at SVB Asset Management, who helps manage and invest the cash
stockpiles of tech firms.
In essence, short-term bonds enable
investors to benefit from higher and lower interest rates at current levels, he
said. As part of a “ladder” strategy, investors can swiftly roll over the
proceeds from maturing debt into similar bonds but with higher yields, juiced
by rising interest rates. That gradually boosts the income earned from a
portfolio of short-dated bonds.
On the flip side, if stocks plunge
or the Federal Reserve arrests its rate hike path, front-end bond yields will
fall, boosting debt prices. Yields and debt prices move in opposite directions.
The
2-year Treasury yield TMUBMUSD02Y, +0.99% trades at
2.831%, close to a 10-year high, according to Tradeweb. The short-dated
maturity’s yield has doubled since last August after traders began to reckon
with the Fed’s determination to raise rates in a steady but gradual manner.
The growing calls to scoop up
short-term government paper runs against the well-observed dynamic of
short-term yields closely tracking expectations for the Fed’s hikes, which, in
theory, leaves them poorly positioned for further monetary tightening. Bonds
prices tend to weaken in a rising rate environment, as existing bonds are
discounted to match the higher yields of newly issued debt.
But Rick Rieder, chief investment
officer of global fixed income at BlackRock, said earlier this month the
short-end had already priced in the impact of two to three additional rate
increases next year.
Short-dated yields have overextended
their climb, he said, insulating investors from expectations of further rate
increases in the coming months. Thanks to their so-called carry, the income
earned from holding on to bonds, a 2-year Treasury note can withstand a further
yield increase of close to 1.4 percentage points without incurring a negative
return over a one-year period, as of September, according to BlackRock’s
calculations.
And for investors who seek a haven
from volatility, front-end bonds have a strong record during stock market
drawdowns. BlackRock’s analysis shows whenever the S&P 500 was down 5% over
a six-month period, the 2-year note yield would fall on average 0.62 percentage
point, much more than the 0.30 percentage point drop observed in the 10-year
note.
Stocks have struggled in recent
weeks as the Fed’s rate increases spark concerns over the sustainability of
earnings growth in the coming quarters and a global economy losing steam, amid
other worries. The S&P 500 SPX, +1.09% is down nearly 10% from its
all-time high set in late September, and the Dow Jones Industrial Average DJIA, +0.97% has shed more than 2000 points
since the blue-chip benchmark established its record peak earlier this month.
Short-dated debt has started to
attract not just professional investors, but households, too. Short-term
interest rates are now lofty enough to lure households from checking accounts
bearing zero deposit rates, wrote Torsten Slok, chief international economist
at Deutsche Bank.
Meanwhile, managers of corporate
cash hoards have also complained of the growing problems in sourcing bonds for
their clients as other buyers wade into the market. Corporate treasuries tend
to invest in short-term fixed-income assets as they can be swiftly sold without
incurring hefty trading losses.
“It’s been difficult to find some of
the short-end bonds we want. We’re getting a lot of nontraditional buyers,”
said Souza.
This
comes as flows into short-term bond exchange-traded funds have perked up. The
iShares Short Treasury Bond ETF SHV, +0.01% has attracted more
than $7 billion of inflows this year, while the SPDR Bloomberg Barclays 1-3
Month T-bill ETF BIL, +0.01% also drew $2.6
billion of inflows, FactSet data shows. Both are up more than 1% for the year.
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