Choosing inflation-linked over fixed-rate bonds

For Ignacio Sosa, director of the product solutions group at DoubleLine Capital in Los Angeles, the current rising-rate environment is the perfect scenario.

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In spring 2016, Sosa and his team forecast that U.S. interest rates had bottomed and would start to creep up. The Renaissance Flexible Yield Fund was launched at that time, which his firm sub-advises, and the “construction of the portfolio reflected that [call].”

That outlook remains. “In terms of Treasurys, the kind we have consist entirely of inflation-linked bonds. In other words, they’re not fixed-rate, and that’s something we think is a positive,” Sosa said during a mid-May interview. With these bonds, the principal and interest payments change with the rate of inflation.

Interest rates in the U.S. have been rising steadily since December 2016, when the Federal Reserve announced a hike for only the second time since they bottomed out during the financial crisis. Since late 2016, the central bank has raised the target range of the federal funds rate four times. It’s currently 1.5% to 1.75%, and CME’s Group’s FedWatch Tool shows markets expect another hike on June 13.

North of the border, the Bank of Canada held at 1.25% at its most recent meeting on May 30—after two hikes in 2017 and one in January this year.

Read: Fed on track to gradually hike rates: minutes

In the U.S., Sosa says, “We are at a very important point. We have said all along that a close of the 30-year bond at above, let’s say, 3.22% or 3.23% in yield is very significant, and could point to higher yields.” This also applies to 10-year Treasurys, he says.

The 30-year reached a nearly three-year high of 3.24% on May 17, he said.

“But will this be sustained? If it is, it would point to higher rates across the board in terms of intermediate and long-term U.S. bonds. But we are prepared for that,” says Sosa.

The U.S. 30-year Treasury had dropped back to a close of 3.02% on May 29.

Read: Why rising yields and market volatility are good signs

Currency and international bonds

For the flexible yield strategy, Sosa and his team look at both domestic and international bond performance. As of mid-May, he said the portfolio had exposure to “dollar-denominated emerging markets. [Those are] a pretty significant position that we have.”

In terms of currencies, they were “somewhat neutral on the U.S. dollar,” Sosa says.

His view is that this isn’t a good time “to take big positions one way or the other. […] But the longer-term view is that the dollar will weaken, and [it’s] been on a 30-year weakening cycle. [There were] some important points where it strengthened but the down trend has been there for 30 years, and we think that continues.”

Also read:

Where to capitalize on currency

Loonie could drop to nearly US$0.70 if export woes continue: report

What’s behind rising bond yields in Canada and U.S.

Where to find higher real yields

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