“Since the summer of last year we have been participating in the Trumpflation trade, but in the past 1.5 months we have become more cautious and have bought US treasuries once again,” Bezalel told the audience at Morningstar UK conference in London on Wednesday.
“Curve steepening, both in Treasuries and also in German Bunds, has stopped as the reflation trade is beginning to be priced out,” he added.
“I don’t believe the low [Q1] GDP number in the US is transitory as the Fed does,” Bezalel said. US treasury yields have therefore hit a ceiling, he believes.
“Over the next three years, $30trn of debt has to be refinanced in the US. At current levels, that would happen at 1% higher rates which translates into $200bn in extra interest payments. That’s 1% of US GDP being thrown out of the window. Treasury yields can’t really go any higher not to cause any distress.”
“And longer term, the three Ds; debt, demographics and [technological] disruption, will weigh on economic activity. I don’t think we will see Treasury yields of 3 or 4% ever again.”
"Longer term, the three Ds; debt, demographics and [technological] disruption, will weigh on economic activity. I don’t think we will see Treasury yields of 3 or 4% ever again"- Ariel Bezalel
Focus on safety
Ian Spreadbury, an unconstrained bond fund manager at Fidelity, also believes now is the time to take some profits and focus on safety, seeing parallels with the credit crunch in 2007.
Back then, the Fed was also in tightening mode while global debt had been rising. “In fact, debt to GDP globally is back beyond the highs of 2006 – the debt bubble is back, it’s only the composition that has changed.”
Both Spreadbury and Bezalel have therefore been switching from (high-yield) corporate debt back to government bonds, and to emerging markets where Bezalel sees “lots of opportunities”. If you believe the Fed will indeed be forced into taking a more dovish view by a worsening macroeconomic backdrop, that makes some sense.
What about Europe?
But what about Europe? Is the outlook not a lot more benign there? And with the ECB as dovish as it can be, there is much to say for a risk-on positioning here.
“I don’t mind being long Europe,” admitted Bezalel. Even though the relative health of most European economies arguably calls for a more hawkish attitude, this isn’t likely to happen. “Draghi is still so dovish just because of Italy. Who would be buying Italian bonds when the ECB steps away?”
With the help of a dovish ECB, the reflation trade will therefore carry on in Europe for some time to come, believes Greg Venizelos, a credit strategist at Axa IM.
“There is scope for further EUR credit outperformance following the outcome of the French elections, although the bulk of the spread retracement is arguably behind us,” he said. “But the European political risk premium could narrow further towards the low teens in basis points (bps) terms.”