Traders torn by rate-hike bets and Ukraine fears seek way out

[SINGAPORE] As Ukraine tensions and US rate-hike bets whipsaw global markets, investors are going back to the drawing board to search for the next big trade.

For Kellie Wood, a money manager at Schroders in Sydney, long-dated Treasuries are the clearest bet as they offer a refuge from Russian risks and possible monetary policy missteps. Citigroup has switched to an overweight position in 5-year US sovereign bonds, while hedge fund K2 Asset Management sees opportunities in sold-off European stocks.

Portfolio managers are trying to get a handle on the recent swings that have left virtually no corner of the market untouched. Benchmark Treasury yields soared as much as 11 basis points last Thursday (Feb 10) on US inflation data before plunging by about a similar magnitude the next day on Russia-Ukraine risks, while major equity indices declined.

"Risk-off can play out from Ukraine, play out from the Fed hiking 50 basis points in March," Schroders' Wood said in an interview. And with rate-hike bets from the US to Europe building by the day, "there's just that risk that central banks do tighten potentially too hard, there's the risk of a policy mistake".

Yields on 10-year Treasuries have climbed about 50 basis points since the start of the year and punched through the psychological 2.00 per cent mark on Thursday. The benchmark then staged a U-turn to trade as low as 1.91 per cent on Friday after the US warned Russia could stage military action against Ukraine.

"This is the year to become defensively positioned whether it's equities or fixed income," said Ken Peng, head of Asia investment strategy at Citigroup's private-banking arm.

"Even without the Ukraine concerns, growth is slowing, inflation is very high - Treasuries are a hedge and portfolio stabiliser even if yields go up a bit more."

Even though risk aversion has turbocharged interest in Treasuries, that hasn't stopped US bonds from posting their worst start to a year in more than 4 decades as expectations of rising borrowing costs build. Ten-year yields were little changed at 1.98 per cent in Asia trading on Tuesday. On the 32nd floor of K2's Collins Street office in Melbourne, George Boubouras is sifting through the noise to look for the next trade. The head of research at K2 sees opportunities in European developed-market equities, including the FTSE Index.

"The backdrop is obviously one of high uncertainties at the moment with the Fed starting to tighten and geopolitical risks, but if you look at game theory we don't think Russia will invade," said Boubouras.

"In that context, there's extraordinary value in core Europe right now."

While funds jostle to position bets, some strategists say it will only be a matter of time before US yields start rising again once the focus shifts back to inflation.

"Historically, geopolitical events often cause an initial risk-off bid to bonds, but once the dust settles, the market returns focus to the growth and inflation fundamentals," said Nick Smyth, strategist at Bank of New Zealand in Wellington.

"We obviously don't know exactly how this will play out, but I suspect it won't have a lasting impact on US Treasury yields and the likely direction of rates is still ultimately upwards."

It's a sentiment shared by strategists at DBS. "The interplay of Fed hike expectations, inflation worries and geopolitical risks around Ukraine are impacting the UST curve," strategists including Eugene Leow wrote in a note.

"Conflict around Ukraine is unlikely to derail Fed normalisation." BLOOMBERG