Treasuries May Get a Boost as Risk-Off Cycle Evolves

Signs point to Treasury outperformance in the next phase of the longest risk-off cycle since December 2016. 

Comment

The longest risk-off cycle since December 2016 continues, now past 24 trading days. One way we define these risk-on / risk-off cycles is by using BofA Merrill Lynch’s global flows index, a measure of asset price momentum among equities, sovereigns, and money markets. We’ve used crosses below and above zero in this index to mark risk-on and risk-off cycles, respectively.

The chart shows the global flows index (top), rising values (orange) indicate flows out of equities and into safe assets. The bottom panel shows the length of the cycle, which at 24 days is just coming into view. On October 16 we noted that days 17-30 of risk-off moves tended to see the U.S. dollar strengthen. The dollar index is +2.3% since. 

We also have another measure for measuring risk sentiment, using the spread between risk-adjusted returns for cycle-sensitive equity sectors (consumer cyclical, financial, technology) and non-cyclical sectors (consumer staples, real estate, utilities). This spread, the difference between average rolling quarterly returns for cyclical and non-cyclical sectors is shown in the bottom panel below. The top panel shows the U.S. 10-year Treasury yield. 

When the underperformance of cyclical equities, on a risk-adjusted basis, drives this spread below zero, it tends to see Treasury yields head lower. This measure is showing the largest outperformance of non-cyclical sectors since July 2016.

Indeed, using cycles as defined by the global flows index, we are approaching a phase that has seen Treasury yields fall. The last chart shows the performance of the Bloomberg Barclays Treasury index during all risk-off cycles since 2000. The shaded area reflects the first 24 trading days of each cycle, which have already passed in this case.

For those cycles lasting this long, Treasury returns have seen a boost over the next two weeks. The median return for the cycle has increased from 50 bps to 160 bps by day 33. The share of cycles seeing Treasury index total returns rise increases from 63% to 86% by day 33.