Our Multi-Asset Views
But there are also structural changes that appear to be altering the fundamental rule that says higher commodity prices lead to more production, eventually driving prices back down. First, energy producers are increasingly responding to shareholder pressure to restrain capital spending and return capital to shareholders. Second, decarbonization is shifting capital spending away from companies’ traditional hydrocarbon base and toward renewables, while also raising the cost of capital and leading to higher production costs and, in turn, carbon pricing. These decarbonization effects are not limited to energy companies. Metals and agriculture are also facing higher costs and potentially lower supply due to climate-related goals. These dynamics suggest lower price elasticity of supply across the commodities complex. Precious metals are a slightly different animal, but higher real yields could be a headwind for performance.
Finally, we would note that investors may benefit from a positive roll yield,3 a result of the futures market being in backwardation4 due to particularly acute shorter-term supply deficits. Taking all of these factors into account, we have moved from moderately bearish to moderately bullish on commodities.
Higher Rates Still a Risk for Credit
We believe a broader cyclical recovery in 2021 will mean higher yields in longer maturities, while central banks will keep short rates pinned. Even though interest rates in the US rose about 100 basis points5 between last August and the beginning of March, risk markets didn’t respond negatively until February. We think that’s because the rise in nominal yields was first associated with a rise in long-term inflation expectations, which risk markets embraced as a healthy byproduct of improving growth. Plus, levered companies can benefit from higher inflation, as it boosts revenues and reduces real debt.
More recently, markets have pushed short-term inflation expectations higher, in effect challenging the Fed to waver from its commitment to keep policy rates at zero until late 2023. We expect this dynamic may induce more rate volatility even though we believe the central bank will maintain its resolve. We also think debt concerns could weigh on the long end of the yield curve. Together, these factors could push 10-year yields to the 2%–3% range in the next 6–12 months.
We have lowered our view on credit from moderately bullish to moderately bearish, given the prospect of higher government bond yields and narrow spreads (FIGURE 3). We are only moderately bearish because improving fundamentals are supportive and demand technicals remain strong, especially from Europe and Asia where US corporate yields are still attractive, with hedging costs having declined. Within credit, we prefer short-duration sectors,6 such as bank loans and certain areas of the securitized market.
We continue to view securitized assets as a way to express a positive view on residential housing, but remain cautious on commercial property, such as malls and offices, where we see enduring stress and which tend to be long-duration assets. Low mortgage rates, declining unemployment, and millennials’ growing demand for housing are potential tailwinds for sectors such as workforce housing and credit-risk transfer.
For its part, EM debt has been walloped by higher US Treasury yields and a stronger US dollar, and appears to be among the cheaper spread sectors in credit. However, we think there may be a stronger case for taking EM risk in the equity markets, so as to avoid the duration risk.
Our Multi-Asset Views