Bond market: ETFs to watch amid rising interest rates, yield curve inversion

BlackRock Americas iShares Investment Strategy Head Gargi Chaudhuri joins Yahoo Finance Live to discuss yield curve inversions and the state of the bond market amid rising inflation and interest rates.

Video transcript

BRIAN SOZZI: OK. Investors have clearly taken note of Fed chief Jay Powell's more hawkish tone on interest rates, as seen in the recent yield curve inversion. All of this is driving interest in commodities as a hedge. To talk about investor sentiment and trends to watch, we have Gargi Chaudhuri, head of iShares Investment Strategy Americas at BlackRock. Gargi, always great to see you here. Look, the inverted yield curve-- do you think people are making too much out of it? Or should one just immediately draw the conclusion that we're probably going to get a recession in 12 months? GARGI CHAUDHURI: Good morning, Brian and Julie. It's so great to be here. Thank you for having me. And to your point, yeah, of course there's been a huge amount of focus on the inversions that took place yesterday on the two stems, part of the yield curve. And obviously, previously, we saw [INAUDIBLE] bonds inverting as well. The reason that investors are focusing on this-- and it's a client question that I'm getting over and over again-- is yes, historically, there have been recessions that have followed the inversion of the yield curve. However, I think the timing of that recession has been anywhere from six months to 26 months. That's number one. The other big point, I would say, is there's a causation correlation issue. So just because a recession has sometimes followed an inversion doesn't mean that it was caused by it. 2019 is a great example. We did have the inversion of the two stems, and then we had a recession, but that was related to the pandemic. So definitely something that I think we're going to be speaking a lot more about. But I don't necessarily think that it immediately points to a recession, especially not in the US, in the near term given the strong jobs market that we're still seeing here. JULIE HYMAN: And Gargi, something that you bring up in your notes to us that I think not too many people have talked a lot about is how to position yourself through the bond market. Because you, of course, look at it through the prism of ETFs. And you guys are looking at a couple of ETFs in the sort of shorter end-- not the shortest, but the shorter end of the curve, and also in corporate bonds. So talk us through those ETFs and why you're looking at them. GARGI CHAUDHURI: Sure, Julie. So I'd say that right now, what the market is pricing in in terms of what we're going to get from the Fed, not just in 2022 but also in 2023, seems already to have moved a little bit beyond what we think will actually get delivered. So we're looking at 2023, which is pricing in close to almost 3% on the Fed funds in terms of how much the Fed funds can go up. We just don't think that's likely to be the case. I don't think that the Fed will ultimately be able to hike that much in 2022 and 2023. So it's a cumulative rate hike. And if you're in that camp that believes that they don't have to hike as much or that they won't be able to hike as much, then the front end begins to look attractive again. And obviously, we saw three-year yields get close to 2.5%. And that does bring into question some of the front-end ETFs, which, again, if you are an investor sitting in cash, it's a great time to be stepping out of cash into those front-end ETFs. And we talked about FHY as one that gives you that exposure to the very front end of the curve. We also like owning the front-end credit, IGSB as one, where corporate default rates aren't going to move up meaningfully. And if you like the [INAUDIBLE] yields that you're getting in the credit markets after the widening we've seen and the back up in yields we've seen, a little bit of value there. And finally, one of the other tickers that we've talked about, especially here, is shorter-dated inflation-linked bonds as well. So [? SPIC, ?] that's moved pretty meaningfully. So any backup is where I would look to own some of that very front-end inflation-linked bonds [INAUDIBLE]. BRIAN SOZZI: Gargi, we're also getting some breadcrumbs on how this coming earnings season might shape up. So you had RH talk about, at length on their calls, continued supply chain challenges. You had Micron, on its earnings call, talk about problems in China because of COVID-related lockdowns. What will you be watching for this earnings season? GARGI CHAUDHURI: Absolutely. Great question, Brian. So three things that I'll be watching. The first one is any kind of pricing passthrough. So we all know that higher prices are here. They're probably going to be stickier for some time. How are different sectors talking about what we now clearly know is not transitory anymore, the stickier inflation? How are they passing it on? Is that through automation? Is that through cutting on or getting more productivity somehow through technology or the use of technology? So that's one. The second that I'll be watching for, which is quite topical now, is around supply chains and what companies are doing to reassure, if at all, or what companies are doing to focus more on just-in-case supply chains as opposed to just-in-time supply chains, so the idea that we might be looking for more resiliency in our supply chains as opposed to just the cheapest option. So any language around supply chains is what I'm going to be watching for. And then thirdly, of course, like everyone else, I'm going to be looking out to see how much companies are guiding for the future, if they're guiding up or down, and how some of those revision ratios look like. JULIE HYMAN: And of course, the suspense over how much women are willing to pay for their Lululemon [INAUDIBLE]. There's another area too where we have seen enormous increases in prices. And that's, of course, in the underlying commodities. How sustained do you think those increases are going to be? GARGI CHAUDHURI: So back to Lululemon session, which was really fantastic to watch. I'll say she was talking a lot about the elasticity. I think the area where you probably are going to see a lot less elasticity than the Lululemon is actually in the food area, so obviously with food prices going up, with fertilizer prices going up. We spend a lot of time focusing on energies as a part of the commodity market but really thinking about food as well as energy prices, and of course, the industrial and precious metals as well. So a lot of reasons to think about why commodity prices can be a good diversifier in your portfolio, but not just one specific commodity. Let's not just choose energy because oil prices have gone to above $100. Let's really think about a basket of commodities which includes energies but which also includes food, which also includes your industrial and precious metals, many of those which can be your safe haven allocations. But many of those will be structurally used for a longer period of time in this decarbonized world that we are moving towards. So really having that basket, such as COMT or CMDY, which are two ETF tickers that investors are flowing into, I think, not only gives you that inflation hedge, which we know is very important, but is also a diversifier away from your equity and your bond [INAUDIBLE]. BRIAN SOZZI: Well I'm done sharing my analysis on Lululemon today, Gargi, because I just realized I'm not going to win. So I'm just going to cut my losses and keep moving. Gargi Chaudhuri, head of iShares Investment Strategy Americas at BlackRock, always good to see you. We'll talk to you soon. GARGI CHAUDHURI: Great to be here. Bye.