SUMMARY
Equities and bonds have tended to move in the same direction lately. This creates challenges for investors seeking to build portfolios.
Longer-term US Treasury yields have been on the rise.
For example, the 30-year Treasury yield – the interest rate that the US government pays to borrow over three decades – came close to multi-decade highs in the week of May 23.
This wasn’t just a US phenomenon. Bond yields elsewhere pushed higher, particularly in Japan. Yields move inversely to prices, such that rising yields mean falling bond prices.
So, what is going on?
One factor is concern around US budgetary discipline.
The Trump administration’s legislation to cut taxes could widen the already-large deficit further.
Moody’s – the credit rating agency – highlighted this when it downgraded the US’s rating last week.
However, it’s not the only likely reason for the rise in yields. We believe investors have lost some of their appetite for US assets such as Treasuries because of the current tensions over the Trump administration’s tariffs.
Higher tariffs also threaten to push up inflation in the US. More inflation erodes the real value of bond principal and coupons. Investors thus demand higher yields as compensation.
We are closely monitoring the rise in yields globally, particularly in Japan.
The increase in Japanese yields reflects a significant shift in its central bank’s policy.
For decades, the Bank of Japan (BoJ) has sought to boost the economy by purchasing domestic government bonds, thus lowering borrowing costs.
As it has moved away from such purchases, though, yields have risen.
However, if the BoJ subsequently decides to buy domestic government bonds at higher yields, it may sell some of its $1.1 trillion holdings of US Treasuries to do so.
That would put further upward pressure on Treasury yields.
All this creates complications for global investors, who traditionally look to government bonds to help mitigate certain risks in their portfolios.
Often, during rough times for equities, the likes of US Treasuries have gone up in price. Lately, though, equities and fixed income have fallen together.
The current challenges around diversification
Diversification is an important consideration for investors right now, given the macroeconomic risks.
In the coming months, global growth may suffer from likely trade-related disruptions. Consumer demand may weaken, rising bond yields could dent sentiment, while the US could seek slowing economic activity alongside higher inflation later this year.
Such conditions would likely impact equities and bonds negatively.
On balance, we are debating the efficacy of US and global bond duration to help diversify equity risk and have leaned short.
Our tactical positioning
Citi Wealth’s Global Investment Committee decided to leave our tactical asset allocation unchanged at its meeting on May 22.
We remain cautiously neutral on global equities. Our bias is still toward higher quality equities with the scale and balance sheets to weather macro uncertainty.
In fixed income, we continue to hold slightly shorter overall duration than our strategic benchmark.
We also remain underweight high yield and emerging markets credit, while maintaining our overweight in a diversified basket of investment grade credit.
Globally, we stay underweight non-US sovereign developed market bond issuers.
We made no changes in our holdings of diversified investment grade credit, due to its high-quality bias and additional income potential.
Meanwhile, incorporating high quality non-US assets and other diversifiers in global portfolios is something we are exploring.
