On paper, this call gets some support right now from U.S. unemployment close to 50-year lows, Friday’s report showing first-quarter U.S. growth at 3.2 percent, and record stock prices. While Fed funds futures show traders wagering the central bank’s benchmark will fall this year, Goldman Sachs Group Inc. said last week it reckons the next move is likely to be a hike, potentially in the final quarter of 2020.
Dan Ivascyn at Pacific Investment Management Co., for one, is playing defense.
“Rates are at risk of a second-half pullback,” the chief investment officer said in an internal video broadcast published last week. “We could see an uptick in growth, even an uptick in inflationary pressure, and that would lead to likely higher rates.”
Federal Reserve officials conclude a meeting on Wednesday amid expectations they will keep rates on hold.
Whether it’s the Fed’s fear of entrenched disinflation as growth cools, a bet that long-term neutral rates are aggressively low, or ceaseless fixed-income demand to hedge stocks, investors are taking big duration bets as inflows boom.
The term premium, or the compensation investors demand for holding longer-maturity U.S. debt over short-term obligations, remains close to record lows.
Moral Hazard
Still, Desai’s caution is warranted by the theory. A half-percentage point jump in yields would spur more than a $1.5 trillion loss to the value of global high-grade bonds, according to one measure of interest-rate sensitivity.
The risk is that investors are scooping up bonds safe in the knowledge the U.S. central bank is at their beck and call, just as opaque markets like private debt boom, Desai warns.
“It’s a moral-hazard play largely -- the notion that the Fed is always going to come and bail us out,” she said. “The pivot in the first quarter was essentially the Fed choosing to exchange volatility today for what actually is an unknown quantity of volatility in the future.’’