Quick Takes: Rising Rates and Short-Term Opportunities
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Text on screen: PIMCO Quick Takes: Rising Rates and Short-Term Opportunities
Text on screen: Jerome Schneider, Head of Short-Term Portfolio Management
Jerome Schneider: For investors over the coming quarters, they're undoubtedly going to be focused on the tightening monetary policy that's before us, both here in North America, but globally. Specifically for investors, what they should be focused on is the changing liquidity conditions and financial conditions which come along with higher rates and a reduced balance sheet from the Federal Reserve.
Full page chart -- TITLE: Heightened front-end U.S. Treasury yields help create a buffer for rising rates. The second complementary chart plots the U.S yield curve across 1 month, 6 month, 1 year, 2 year, 3 year, 7 year, 10 year, 20 year and 30 year U.S. Treasury yields, calling out that 2 year Treasury yield rose 145 bps higher since hitting its low on August 4, 2020, and that forward yields suggest that most if the rate move higher is likely behind us. Source: PIMCO and Bloomberg.
As this chart illustrates, 2-year notes are well in excess of 1.5 percent which means that a lot of the rate hiking sequence has been effectively priced into the marketplace.
Full page chart -- TITLE: Heightened front-end U.S. Treasury yields help create a buffer for rising rates. Bar chart that shows the required rate increase for negative returns by plotting U.S. Treasury rate increases across 6 month, 1 year, 2 year, 3 year, 7 year, 10 year, 20 year and 30 year U.S. Treasuries for two periods: 2/10/22 and 12/21/2020. It shows improving prospects for forward-looking yields.
The higher yields exhibited through the fourth quarter of last year and the first quarter of this year we believe provide ample cushion and carry to the income portion of portfolios, well outpacing the prospect of potential Fed hikes over the course of the next two quarters, and more importantly, potentially providing a shield against higher rate expectations than the market is currently expecting.
When we think about managing liquidity, we still want to be defensive. We want to think about portfolios which are resilient, but yet have degrees of freedom to pivot when we find those opportunities.
Since the beginning of the year, the carry contribution has gradually increased, in response to the expectation of forward interest rates within the U.S. money market curves.
Full page graphic -- TITLE: – Stepping out of money market funds can provide a meaningful increase in yield potential”; Image of three steps with a blue arrow going from the bottom step to the second step. Additional text and bullets in the step image: SUBTITLE – PIMCO short-term strategies may offer investors; BULLETS –Active management; Broader opportunity set; Increased return potential; Liquidity preservation; Defense against volatile markets; Resiliency in a rising rate environment
For those investors who are wanting to take advantage of the rising rate expectations, we would suggest a more active approach to doing so, we believe this is an opportune environment to step out of cash, step out of money market funds and bank deposits, which will remain near zero for the foreseeable future.
As such, we look at 2022 as being a constructive period, much more constructive than we saw in the previous 2 years.
There's a couple of key considerations to take into account. Number one, yields have actually moved higher already in the front end, and taking into account many of the rate hikes which the Federal Reserve has forecasted over the course of 2022.
Text on screen – Key Take-aways: Duration, Bias to own slightly more interest rate exposure, Corporate Credit, Favor financials due to solid fundamentals, Senior Securitized Credit, Loss-remote senior tranches at the top of the capital structure, Non-USD denominated, Opportunities with attractive yield when hedged back to USD
As such, owning some interest rate exposure in the front end is actually a good source of carry and income to portfolios at this point in time in modest amounts. Secondly, corporate credit remains a focal point for most investors in the front end. However, we still encourage people to be defensive, and more importantly, be very selective in terms of those criteria, as spreads remain remarkably thin at this point in time. Third, look into structured credit, and more importantly, securitized product. They can provide not only income and carry, but also be defensive, should we find other bouts of volatility on the horizon.
And then finally, look to find sources of liquidity premiums. For us here at PIMCO, we like our clients to think more globally speaking, by looking to non-dollar asset classes to extract liquidity premiums.
Images on screen: PIMCO trade floor
This flexibility will ultimately provide our clients with the ability to seek those premiums and potentially earn carry, well in advance of what money market funds or bank deposits could potentially yield through the course of 2022
Text on screen: For more insights and information, visit pimco.com
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