Term premium to rise, QIC says

Term premium to rise, QIC says

Fixed-income investors should be factoring a rise in the term premium into their planning, according to institutional investment manager QIC.


The QIC Global Liquid Strategies (GLS) team is “conservatively” anticipating a normalisation of about 50 basis points, the company said in a statement.

“For some years now the term premium has all but evaporated, or even been in the negative,” said GLS managing director Susan Buckley. In essence this means there’s been no excess compensation for investors holding long-term debt.

“But we have identified global factors that signal a return to higher levels and believe investors should act upon this return sooner rather than later.”

Those factors include a normalisation of monetary policy following the withdrawal of of quantitative easing by the US; investors’ demand for higher compensation to counter increased illiquidity caused by increased regulation in the finance sector; and the general expectation of higher interest rates and inflation, the statement said.

Another driver is the nearing of peak foreign ownership of US treasuries and sovereign investors’ consequent move to new asset classes, QIC said. This includes increased interest in the Chinese renminbi as a currency, coinciding with the debate about its inclusion in the IMF’s standard drawing right basket and its new, more freely traded basis, the statement said.

“Investors should understand that the return of the term premium does not signal a return to ‘normal’,” said GLS research and strategy director Katrina King.

“The four most dangerous words in economics and markets are said to be ‘This time is different’. Well, this era really is different. For a start, the term premium has spiked three times since the global financial crisis, showing that that term premium can move quickly and undercut unprepared portfolios.”

“Then there is the emergence of new risk, illiquidity, which investors are only now starting to give thought to,” she said. There is a rising tide of commentary on the new threat, but few ideas on how to counter it.

QIC’s view is that fast, targeted responses to market adjustments will be critical for success. Inflation protection and inflation-related assets warrant renewed attention as will favouring short rates positions when valuations show mispricing, QIC said.

“Rising inflation should not be a source of alarm – we are looking at moderate levels that we believe offer return opportunities for investors that look beyond the present and signal a welcome step-change in the post-GFC era,” Ms King said.

 

 

Term premium to rise, QIC says
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