AQR Bond Quant’s ‘Sacrilegious’ View: Look Beyond Fed’s Policy
AQR Bond Quant’s ‘Sacrilegious’ View: Look Beyond Fed’s Policy
(Bloomberg) -- AQR Capital Management’s co-head of fixed income set out to make clear what causes longer-term bond yields to rise and fall -- one of the most pressing concerns for traders as of late.
What Jordan Brooks found is that investors tend to overemphasize policy decisions from the Federal Reserve and other central banks, rather than focusing on the larger economic forces at work across the globe.
“This may sound sacrilegious, but occasionally the role of central banks in markets can be overstated,” Brooks wrote in a white paper published Monday titled “What Drives Bond Yields?”
“Expectations of future interest rates, particularly at long horizons, and term premia are largely driven by economic factors beyond the current monetary policy stance,” he wrote. “The economy and markets face extraordinary challenges. But it is during these times one needs to remember the playbook, not throw it out the window.”
AQR, the fund manager known for popularizing quantitative investing, is addressing investor jitters over benchmark U.S. Treasury yields plunging this month to levels that would have been record lows in pre-pandemic times. Stocks dropped at the start of last week on fears that government bonds were indicating the global economy had reached peak growth.
Brooks acknowledged the strong influence of central banks over the interest-rate outlook in the near term. Yet growth projections and long-term inflation expectations are more crucial in assessing bond yields, he found. The Fed’s next policy decision is on Wednesday.
Economists expect U.S. economic growth will moderate to 2.4% by 2023, according to a Bloomberg survey. Meanwhile, even with the highest readings of core U.S. inflation in decades, expectations for price changes over the next five to 10 years remain within their recent historical average, according to University of Michigan data.
The two factors can “account for the entirety of the secular decline in U.S. Treasury yields over the last two decades,” Brooks wrote. Risk aversion, inflation uncertainty and demand for government bonds also play a role.
AQR, led by founder and Chief Investment Officer Cliff Asness, has been building a quantitative fixed-income business, which is also becoming more popular among its Wall Street rivals. Asness defended a strategy that favors cheap-looking stocks in a webinar earlier this month -- the value trade that benefitted earlier this year from increasing growth expectations and rising government bond yields.
Even with U.S. yields near the lowest since February, Brooks sees both upside and downside risks ahead.
“Assuming government bond risk is highly one-sided, with low interest rates implying there is no room for bonds to rally, is misguided,” he wrote. On the flip side, “should we see a de-anchoring of inflation expectations, perhaps driven by fears over the extraordinary levels of fiscal and monetary stimulus,” then long-term yields would be pressured higher.
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