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February 20, 2021

What’s in Store for Real Rates in the U.S.?

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Global Multi-Asset Viewpoint

What’s in Store for Real Rates in the U.S.?

What’s in Store for Real Rates in the U.S.?

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February 20, 2021

 
 

It is well understood that the recent ‘everything bubble’— in which valuations for most major financial assets have reached historical extremes—is predicated on low real rates and the perception of their sustainability. Low real rates have also been viewed as an important driver of newly emergent trends, including U.S. dollar weakness and a bullish outlook for commodities. Any interruption to this low real rates regime could threaten valuations, and thus represents a major risk to the current market environment. We believe a further moderate back up in real rates is possible later in 2021 in the context of the strong U.S. economic growth that we expect this year. However, over the medium-term, that is over the next 2-3 years, this increase in real rates may prove fleeting as longer-term budgetary and debt dynamics will likely require real rates to be even lower than they are today.1

The U.S. 10-year TIPS (Treasury inflation-protected securities) yield, at -65 basis points today, is only moderately above its level in the third quarter of 2020, despite a substantial improvement in global growth which has historically been an important driver. Today’s global composite PMI reading of 52.9, for example, would suggest that the U.S. 10-year real yield should be about +34 basis points, or about +100 basis points above current levels.2 The current break with the historical relationship between global growth and real yields to a significant degree reflects an altered perception of economic policy, future constraints of budget and debt dynamics, as well as a downward reassessment of trend growth.

 
 

1 MSIM Global Multi-Asset Team Analysis and Estimates, Haver. Data as of March 12, 2021.
2 MSIM Global Multi-Asset Team Analysis, Haver. Data as of March 12, 2021.

Forecasts / estimates are based on current conditions, subject to change, and may not necessarily come to pass.

 
cyril.moulle-berteaux
Head of Global Multi-Asset Team
Global Multi-Asset Team
 

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There is no assurance that a portfolio will achieve its investment objective. Portfolios are subject to market risk, which is the possibility that the market values of securities owned by the portfolio will decline and that the value of portfolio shares may therefore be less than what you paid for them. Market values can change daily due to economic and other events (e.g. natural disasters, health crises, terrorism, conflicts and social unrest) that affect markets, countries, companies or governments. It is difficult to predict the timing, duration, and potential adverse effects (e.g. portfolio liquidity) of events. Accordingly, you can lose money investing in this portfolio. Please be aware that this portfolio may be subject to certain additional risks. In general, equity securities’ values also fluctuate in response to activities specific to a company. Investments in foreign markets entail special risks such as currency, political, economic, and market risks. The risks of investing in emerging market countries are greater than risks associated with investments in foreign developed countries. Fixed-income securities are subject to the ability of an issuer to make timely principal and interest payments (credit risk), changes in interest rates (interest-rate risk), the creditworthiness of the issuer and general market liquidity (market risk). In a rising interest-rate environment, bond prices may fall and may result in periods of volatility and increased portfolio redemptions. In a declining interest-rate environment, the portfolio may generate less income. Longer-term securities may be more sensitive to interest rate changes. High yield securities (“junk bonds”) are lower rated securities that may have a higher degree of credit and liquidity risk. Mortgage- and asset-backed securities (MBS  and ABS)  are sensitive to early prepayment risk and a higher risk of default and may be hard to value and difficult to sell (liquidity risk). They are also subject to credit, market and interest rate risks. Certain U.S. government securities purchased by the Portfolio, such as those issued by Fannie Mae and Freddie Mac, are not backed by the full faith and credit of the United States. It is possible that these issuers will not have the funds to meet their payment obligations in the future. Real estate investment trusts are subject to risks similar to those associated with the direct ownership of real estate and they are sensitive to such factors as management skills and changes in tax laws. Derivative instruments can be illiquid, may disproportionately increase losses and may have a potentially large negative impact on the Portfolio’s performance. Illiquid securities may be more difficult to sell and value than publicly traded securities (liquidity risk). By investing in investment company securities, the portfolio is subject to the underlying risks of that investment company's portfolio securities. In addition to the Portfolio's fees and   expenses, the Portfolio generally would bear its share of the investment company's fees and expenses. Subsidiary and tax risk the Portfolio may seek to gain exposure to the commodity markets through investments in the Subsidiary or commodity index-linked structured notes. The Subsidiary is not registered under the 1940 Act and is not subject to all the investor protections of the 1940 Act. Historically, the Internal Revenue Service ("IRS") has issued private letter rulings in which the IRS specifically concluded that income and gains from investments in commodity index-linked structured notes or a wholly-owned foreign subsidiary that invests in commodity-linked instruments are "qualifying income" for purposes of compliance with Subchapter M of the Internal Revenue Code of 1986, as amended (the "Code"). The Portfolio has not received such a private letter ruling, and is not able to rely on private letter rulings issued to other taxpayers. If the Portfolio failed to qualify as a regulated investment company, it would be subject to federal and state income tax on all of its taxable income at regular corporate tax rates with no deduction for any distributions paid to shareholders, which would significantly adversely affect the returns to, and could cause substantial losses for, Portfolio shareholders. Cryptocurrency (notably, Bitcoin) operates as a decentralized, peer-to-peer financial exchange and value storage that is used like money. It is not backed by any government. Federal, state or foreign governments may restrict the use and exchange of cryptocurrency. Cryptocurrency may experience very high volatility. LIBOR Discontinuance or Unavailability Risk. The regulatory authority that oversees financial services firms and financial markets in the U.K. has announced that, after the end of 2021, it would no longer persuade or compel contributing banks to make rate submissions for purposes of determining the LIBOR rate. As a result, it is possible that commencing in 2022, LIBOR may no longer be available or no longer deemed an appropriate reference rate upon which to determine the interest rate on or impacting certain derivatives and other instruments or investments comprising some of the Fund’s portfolio. Portfolio Turnover. Consistent with its investment policies, the Fund will purchase and sell securities without regard to the effect on portfolio turnover. Higher portfolio turnover will cause the Fund to incur additional transaction costs.

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