(Bloomberg) -- US Treasuries are offering investors solid protection against losses as yields remain elevated, according to BlackRock Inc.
The asset manager sees inflation and growth moderating from the first half of this year. That shift – alongside the broader impact of artificial intelligence and evolving economic conditions – is creating "a richer opportunity set in fixed income," Chi Chen, a senior portfolio manager wrote in the firm's third-quarter fixed income outlook.
With Treasury yields out to the 10-year trading well above 4% and longer maturities sitting above 5%, investors are getting better compensated for holding bonds, according to Chen, who noted that the market offers "increasingly compelling" valuations. BlackRock's view comes as 30-year bond yields have some investors concerned about growing debt and sticky inflation.
Bondholders focused on the long-term are better protected against losses, BlackRock says.
"Current yield levels provide a substantial cushion against further rate selloff," wrote Chen, who helps co-manage BlackRock's $18 billion BlackRock Total Return Fund. BlackRock estimated that 10-year Treasury yields would need to jump roughly 70 basis points from current levels before generating negative total returns over a one-year horizon.
A Treasury selloff that began late February intensified this month, sending yields sharply higher. Traders are pricing a quarter point interest-rate hike in September, with October also fully priced based on swap contracts. The market prices 0.45 percentage point of tightening by the end of this year. The two-year yield rose to its highest level of the year at 4.33% on Thursday, well above the Federal Reserve's current policy setting of 3.5%-3.75%.
"Markets are pricing a more hawkish path for Fed policy than we expect," Chen wrote.
BlackRock, the world's largest asset manager with $15.3 trillion in assets under management, outlined four potential 12-month return scenarios for the Bloomberg US Treasury Index.
A Fed on hold is seen generating a 6.4% return, while 50 basis points of rate cuts should boost that to 7.2%, the note said. Central bank hikes of 1 percentage point are seen clipping gains to 2.5% next year, while a recession and 1.5% of easing would boost Treasury gains to 11.6%.
So far this year, the Treasury gauge has been 0.7% lower, with the selloff in rates for July generating a monthly loss of 0.9% as of Wednesday's close.
Separately, BlackRock managers said new Fed Chairman Kevin Warsh has "recognized that credibility remains the central bank's most powerful policy tool," when inflation has been running above the central bank's long running target of 2% for the past five years.
"Those words will ultimately need to be backed by actions — or by moderating inflation," they said.
Other points of consideration from BlackRock's quarterly outlook include:
In bonds, the firm favors "an income-first approach rather than taking large directional duration positions until the data more clearly validates a turn"
Credit "remains supportive for carry" and relatively tight risk means "future returns are likely to depend less on spread tightening and more on earning and compounding income over time"
Investors should seek rewards from "careful underwriting, disciplined security selection and identifying resilient sources of income rather than simply chasing broad market exposure"
Securitized assets have valuations that "remain compelling on a quality-adjusted basis"
Efforts to reduce the Fed balance sheet are likely challenging and BlackRock notes that large central bank holdings "amid much higher indebtedness," suggests "the implicit debt monetization of the past two decades seems difficult, if not impossible, to unwind without significant fiscal consequences"
(Updates prices in sixth and 10th paragraphs.)
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