Resumption of bonds as a buffer against market shocks

The recent surge in government bond yields is a gift for any fund manager worried about market risks ranging from geopolitics to leverage.

It is true that the first quarter of this year has not been fun for holders of government bonds, the price of which has fallen on the largest scale in four decades. But bond bulls took one for the team.

The pullback means that just as Russia and the United States are once again locking the horns, and as Archegos’ implosion raises concerns about the potentially systemic risks stemming from abundant global leverage, corporate bonds ‘State again provide a kind of safety net.

Led by the U.S. rate market, the world’s largest and a base for global asset prices, bonds fell in the first few months of 2021, frightened by the possibility of higher inflation as the he global economy is emerging from pandemic lockdowns.

Bondholders feared that oversized fiscal stimulus packages, especially in the United States, could cause consumer prices to rise fast enough that regular fixed bond yields would appear to decline or even decrease. that central banks could signal their intention of essential monetary support – really, the stuff of investor nightmares.

For some fund managers, the returns are still too low. But for others, they are now high enough to protect blended portfolios against a range of risks and to act as a buffer that has helped create a respite from volatility.

At the longer end of the maturity spectrum, US 30-year debt is now yielding about 2.3 percent. It is towards the lower end of the range that has prevailed for most of the past decade. But compared to the 0.7% collapse in the darkest days of the 2020 coronavirus crisis and the 1.3% square footage it held for most of the year, it is positively sumptuous.

This provides investors with an extremely safe asset that they can use to balance risks in other areas. Eric Lonergan, a macro hedge fund manager at M&G Investments, said he added 30-year US debt to his portfolio because it now offered “a margin of diversification.”

“You don’t care about diversification when the going is good,” he says. “You care when something is wrong. Right now, I am convinced that if this happens, Treasuries will do well. It is insurance against anything. . . except much higher US inflation. “

Global stock indices remain at or near record highs and, without a strange change in attitude from central banks, they appear destined to continue to push higher. But geopolitics – including clashes between Russia and Ukraine, and China and Taiwan – or acts of God like natural disasters, can still erupt and trigger a rush for safe pensions that will rise in price when the going. get complicated.

But it’s not just the actions of God and politicians that play on the minds of investors. Some also point to the recent explosion of the Archegos Capital Management family office as a sign that the markets are strewn with volatile excesses.

Bill Hwang’s Archegos failed in large part because of leverage. His bets were too concentrated, leaving him stranded when a title fell. But the incident hit harder because the bets were overloaded with loans. The rampant use of total return swaps, which allow users to bet on the price of a stock without actually owning the stock, meant that he was in fact praising investment bank balance sheets on a staggering scale.

Considered alongside the surge in trading by inexperienced hobbyists in January – sometimes, again, using leverage, albeit on a much smaller individual scale – and the relentless frenzy for cryptocurrencies and even digital art makes it easy to build a case that the ocean of cash roaming the world system could easily, and unexpectedly, capsize some ships.

“We should not underestimate how, in an increasingly interconnected global financial system, ‘things are going,’ wrote Steven Major, chief bond analyst at HSBC and one of the loudest voices in favor of continued investor demand for bonds.

“There is too much leverage in the system, much of which may not be visible until something happens. And when those shocks do occur, the money is funneled into the safest of safe havens, with US government bonds invariably the first choice. “

It may be too dark. Bond specialists, after all, thrive in disaster – it’s their job to think about things that can go wrong. And a reflection on the leverage effect is already underway among banks and regulators. Still, it’s not hard to imagine leverage gaining ground as a pressing global concern and bond markets taking over.

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