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BlackRock Downgrades U.S. Government Bonds

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What You Need to Know

  • The downgrade is a tactical move that applies to portfolios over the next 6-12 months.
  • It's based largely on expectations of rising inflation as economies continue their recoveries.
  • The U.S. 10-year Treasury yield reached its highest level in a year.

BlackRock, the world’s largest asset manager, has downgraded government bonds to underweight for the next six to 12 months due to rising inflation expectations, which have already increased bond yields.

The 10-year U.S. Treasury yield topped 1.4% in early trading on Wednesday, reaching its highest level in a year.

“Inflation expectations have risen sharply while real rates [rates adjusted for inflation] are steady in negative territory,” according to the firm’s weekly commentary from the BlackRock Investment Institute headed by Jean Boivin. “We expect a strengthening economy, a huge fiscal impulse and rising inflation to further drive up nominal yields this year, albeit by less than in similar periods in the past.”

BlackRock strategists noted that “medium-term inflation risks look under-appreciated.”

As a result of its revised medium-term outlook, BlackRock increased its underweight in U.S. Treasuries and favors inflation-linked bonds. It has also downgraded European peripheral bonds — from Spain, Ireland, Italy and Portugal — to neutral since their yields are near record lows and their spreads have narrowed. 

Favoring Developed Market Equities Over Bonds

BlackRock now prefers equities over bonds because their valuations “appear more attractive,” especially from developed markets, which it says are “best positioned to capture the opportunities” that arise from economies that reduce their dependence on fossil fuels and undertake other changes in what BlackRock calls their “climate transition.” BlackRock favors tech and health care sectors. 

Its concerns about rising inflation, which are shared by a growing number of asset managers, are not shared by Federal Reserve Chairman Jerome Powell or U.S. Treasury Secretary Janet Yellen.

In his second appearance on Capitol Hill on Wednesday, Powell acknowledged that inflation will rise later this year but largely because of comparisons to extremely low inflation a year ago, what he calls “base effects.” He stressed, as he did at his appearance Tuesday on the Hill, that the Fed has “the tools to deal” with that.