TINA is dead. Or maybe “sick” is better.
There is suddenly an alternative. And that alternative is cash.
Last week, BofAML was out suggesting the safe haven appeal of 10Y Treasurys might be diminishing and their rationale was simple. To wit:
The typical haven characteristic of Treasury debt is being hindered by the appealing rates of return on cash in the US. Historically during periods of market turbulence, money would flow from risky assets (such as stocks) into US Treasury bonds. But with $ Libor at 2.36%, support for Treasury debt is diminishing (consider that 5yr Treasury yields are 2.84%). In other words, the rise of “cash” as an asset class is altering the traditional allocation decisions of multi-asset investors in times of market stress.
Chart 5 highlights this point. We show the rolling 1yr correlation between total returns on 10yr Treasury bonds and the total returns on stocks (daily returns). We overlay this with the evolution of 3m $LIBOR.
“With YTD returns offering an unwelcome reminder of the downside potential associated with many assets, and nearly 2.5% now available in $ entirely risk-free, why should investors take the risk on holding anything else?,” Citi’s Matt King recently asked, on the way to noting that the gap between $ LIBOR and USD IG is now the lowest since 2007.
I’ve talked quite a bit of late about the substitution effect inherent in all of this. The bottom line is that as real rates rise and as the effects of the technical short-term funding squeeze that played out in Q1 linger on the way to (hopefully) abating, investors are for the first time in quite a while pondering the relative merits of simply going to cash. That informs one part of Goldman’s most recent asset allocator, out Monday evening, in which the bank recommends an Overweight in cash for the next three months.
The bank notes that the risk-reward outlook has deteriorated with the demise of “Goldilocks” and considering the prospect that bonds and stocks might not diversify one another (diversification desperation as the return correlation flips positive with rising long end yields serving as a headwind for equities), cash is looking pretty attractive following the short-term funding squeeze that played out in Q1.
“With near-term conviction levels and potential risk-adjusted returns lower, we also upgrade cash to OW for 3m,” the bank writes, adding that “this should help lower portfolio risk and with the Fed funds rate moving higher and more opportunities in short-duration fixed income and money markets, we think cash is more attractive on a relative basis.”
They continue as follows:
With the Fed funds rate moving up faster than inflation, and thus rising real rates in the front-end, the competition from cash for other asset classes has picked up. Short-duration US fixed income has also become more attractive due to the liquidity drain from a sharp increase in US T-Bill issuance (Exhibit 22). This has also put upward pressure on US money market spreads and driven wider spreads in shorter-dated corporate credit and commercial paper.
Goldman includes the obligatory caveat which speaks to the abating pressure illustrated in the right pane:
Our economists expect a modest decline for T-bill issuance going forward, which should help alleviate the technical supply pressure that weighed on money market spreads.
But that aside, the situation simply is what it is. They go on to note what plenty of others have flagged recently, namely that “for the first time this cycle, US 2-year yields are above the S&P 500 dividend yield.”