US Treasuries, yen and gold – are they still safe havens?

Market shifts, potential policy errors and negative sentiment mean the challenge for rattled investors is where to find shelter

Market shifts between risk-on and risk-off environments have been abrupt this year. A growing chorus of central bank hawks in the United States and Europe are rattling investors, as they digest the effects of potential policy errors on equity markets and the economy.

Meanwhile, the possibility of extended lockdowns across eastern Chinese cities and negative sentiment about the country’s economic outlook have spilled over into developed markets, given the potential impact on global economic growth. The challenge for investors is clear: where can they find shelter?

It’s worth noting that all storms eventually pass, as will the negative sentiment pervading global equity markets. The economic support from healthy household and corporate balance sheets should not be overlooked either, while low unemployment rates in many parts of the world are keeping recession risks at bay.

However, the outlook has deteriorated since the start of the year, and economic activity can be expected to moderate and the global economy expand at a more trend-like pace.

Traditionally, safe havens such as US Treasuries, the yen or gold would have offered refuge. However, US Treasury yields have increased by 120 basis points this year, and prices have fallen sharply as markets priced in higher inflation rates and more aggressive monetary policy tightening.

Gold has been more successful at offsetting risks, up by around US$100 per ounce so far this year. But as an asset that produces no income and has its real value eroded by inflation, its performance is somewhat tarnished.

Then there is the yen, which has depreciated by 11 per cent against the US dollar this year.

The yen’s performance against the greenback is being driven by the policy stances of the two countries’ central banks. The US Federal Reserve is set to aggressively tighten its policy in the coming month. Meanwhile, the Bank of Japan is still firmly defending its yield curve control policy and the upper limit of the 10-year Japanese government bond yield. This policy divergence and the low probability that authorities will step in to stabilise the exchange rate mean the yen is likely to remain under pressure in the near term.

So what can investors do to brace themselves against the storm? First, they should assess their portfolio balance. Global bond markets have priced in a lot of the expected policy tightening and the inflation outlook.

US Treasuries are more appealing today than a few months ago given the rise in yields. Moreover, while a recession appears unlikely in the coming year, there are risks to the broader growth outlook and bonds now offer some protection against a bigger growth scare.

While there is scope for US Treasury yields to rise further, any increase is not likely to be as large as the moves already seen this year, but it would still inflict capital losses.

Bonds aren’t, and can’t be, the only answer. Limitations of government bonds have become increasingly evident, as the trusted negative correlation to equities has been tested repeatedly this year. Rather, other defensive or higherincome strategies should now be considered.

Hedge funds offer alternatives, such as hedged equity (buying equity and securing a hedge in the form of options or futures contracts or assets that would behave in an uncorrelated manner), relative valuation (comparing the price of an asset to the market value of similar assets) and a global macro strategy (making decisions based on analysis of macroeconomic or geopolitical events).

Such strategies can utilise increased market volatility and the range of potential outcomes, as they have historically performed better amid volatility and when the chances of mispricing are higher. Meanwhile, real assets – physical assets such as real estate – that offer higher steady streams of income can add another layer of diversification.

While higher bond yields in US Treasuries may have improved their ability to offset equity risks, it’s not as great as it once was, and there is a growing need for alternative assets and strategies to protect portfolios.

There is a growing need for alternative assets and strategies to protect portfolios