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(Bloomberg) — UK asset manager Schroders Plc has closed its short position in government bonds, citing the increased risk of recession.
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Patrick Brenner, chief investment officer for multi-asset at the £800 billion investment firm ($1.08 trillion), said the switch reflects concerns that the Middle East conflict is now more likely to hurt economic growth than lift price pressures.
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On Thursday, oil prices reached a four-year high of $126 a barrel, stoking recession fears while threatening to intensify price pressures in a so-called stagflationary scenario.
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“Whereas previously our risk scenarios were heavily skewed towards inflation with virtually no risk of recession, we now see a more balanced trade-off between inflation and growth,” Brenner told clients in a note. “Against this backdrop, we have closed our short government bond position.”
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He said he’s upgraded European bonds, in particular Italy, seeing the current expectations for interest-rate hikes as excessive. While the European Central Bank is expected to hold rates steady later on Thursday, traders are wagering it will deliver three rate hikes by year-end to combat the impact of higher energy prices.
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The sharp rises in bond yields across the region imply that valuations are no longer expensive, “removing a key driver behind our negative stance on government bonds over the past six months,” Brenner added.
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Bonds have underperformed in recent weeks as the conflict has roiled global supply chains, lifted inflation expectations and raised the prospect of additional government spending to soothe the impact of higher fuel prices.
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However, with the war now in its third month, many investors are concerned economic activity is likely to suffer a greater hit. Recent data releases globally have confirmed those fears, with German retail sales and Purchasing Manager’s Index highlighting the risks for Europe.
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Eventually, that could undermine the case for interest rate hikes.
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Brenner said he’s maintaining an underweight position in US bonds, given the relative resilience of the economy. Investment grade bond spreads in particular “offer little protection against the potential stagflationary risks,” he added.
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