The End of the Bond Hedge?

SPEAKER_1 (0:00)

This podcast is brought to you by ReliaQuest. Cybercriminals are constantly attacking. They want your data, they want your identity, they want your innovation. ReliaQuest fortifies your business with a gentic defense, AI that detects, contains and eliminates cyber threats in minutes. It helps your security team move faster at the work that matters most to protect the business now, and delivers insights to help them predict what's next. ReliaQuest, a gentic defense for the enterprise. Learn more at reliaquest.com. That's reliaquest.com.

Luke Vargas (0:33)

The world's biggest wealth fund calls time on government bonds after recent volatility. Plus, diesel prices hit an all-time high, teeing up more inflation from farm to table, and battered by foreign competition, VW banks on six-figure job cuts as part of a desperate turnaround plan.

Stephen Wilmot (0:53)

We're talking a number of job losses that has never been seen before at Volkswagen, which is Europe's largest industrial company. So it really is a seismic magnitude.

Luke Vargas (1:02)

It's Friday, September 4th. I'm Luke Vargas for the Wall Street Journal, and here is the AM Edition of What's News, the top headlines and business stories moving your world today.

The world's biggest sovereign wealth fund is looking to slash its holdings of US treasuries. The head of Norway's oil fund wants to cut the portion of its bond portfolio that's allocated to government debt to 50% from a current 70%, citing recent market volatility and arguing that greater exposure to equity markets would boost returns and limit its exposure to risk. That follows this week's bond market route, which rippled through global markets, unnerving investors unused to major shifts in the traditional safe haven asset. Well, to help unpack the week that was, I'm joined by Ludovic Subran, the Chief Investment Officer at Allianz. Ludovic, in your opinion, what has been driving this route?

Ludovic Subran (1:59)

Oh boy, the bond route really started in the US. It's something that has been creeping up for quite some time. It's a mix of soaring deficits, a Fed unfazed by inflation caused by the many friction points and wars. Certainly, the idea that you can tweak the markets, the interventionism is something that market actors don't like, and there is a bit of AI, a bit of competition for capital, a bit of, you know, is it growth ahead? Is it abundance? Is it inflationary, deflectionary? So all of that has been repricing the US bond market, and this has been sending seismic waves across the world.

Luke Vargas (2:32)

I mean, given that, how are you responding to this as an investor? And should retail investors listening to this be worried about their portfolios, their pensions?

Ludovic Subran (2:40)

Looking ahead, I think it can get worse before it gets better. I think there is this idea that we could see bond yields test new limits because of the situation that is not coming down. We don't see an end of the war in Iran. We don't see an end of the trade war. We certainly don't know exactly how you re-anchor, be it the treasury, central bank type of relationship in many of the countries. We have elections that are very open. So I think all of that are things that could, in the near future, continue to reprice, continue to reprice the so-called safe haven. So I would say to investors, try to mind that and not keep very passive your bond investing. Don't think that you bought some bonds and you're expecting your coupon to pay and you feel very confident about this. Try to be very active. Try to get expert advice to try to see if you can reposition this so that it is something that is benefiting to your portfolio. And more importantly, look also at what you can do on equity because whatever is happening on bond could actually trickle down to equity. So try to make sure that you also protect that part of your portfolio.

Luke Vargas (3:36)

Right, bonds not the hedge they used to be.

Ludovic Subran (3:38)

Bond is not the hedge that used to be. That's over for now.

Luke Vargas (3:41)

Let's move along and talk about another effect of rising yields, an increased government borrowing costs. It's not hard to see how this eventually could lead to a fiscal crisis. But as we've discussed here on the podcast earlier this week, if anything, investors heard too little from G20 finance ministers about their plans to actually address that. Are you expecting any sort of dam to break on this front in the near term where this shifts from being a future, if quite inevitable, risk to a live crisis?

Ludovic Subran (4:09)

Look, I'm watching particularly what is called debt servicing costs. So how much it costs for governments to repay their backlog of debt? How much more points of GDP do they have to pay on a given year for their indebtedness? That's something that is very worrying in Japan, where because of the zero-rate environments, the debt servicing costs were very low, below 3% of GDP, and the forecasts are showing double digits, points of GDP for the debt servicing costs. That's something that I'm very worried about for the US., for the UK. Somehow also France, my country was thriving on debt servicing costs always being below 2% of GDP. Now, it's creeping up to 3% of GDP. It's still very low, it's less than Italy, for example, and this is why I mentioned tax revenue. I think what is very interesting for the G20 is that there is also another race that is happening in the background, is that everybody knows that what could solve this situation, what could soothe bonds village, Gilantes, is a tax increase.