IUSB Is Too Correlated To Equity Markets

The iShares Core Total USD Bond Market ETF (NASDAQ:IUSB) is a broad ETF that follows various credit instruments of different risk in a representative basket of the US bond market. The issue here is still duration, and with the latest wave of Fed comments, speculators need to be aware that the Fed's narrative leans heavily on structural risks associated with inflation and interest rates. They will be heavy handed and IUSB doesn't provide safety from equity market movements as fixed income has in the past. No big reason to dip into this one.

Fed Comments and Inflation

Ordinarily you'd want the fixed income markets to not be correlated to equities, as a place to hide when you want to wait out issues that could be affecting business performance like recession. In the current recession, dictated by productivity issues and rates, duration is correlated to equity market returns.

The Fed is going to be very heavy-handed in its approach to fighting inflation because they continue to be worried about wage-price spirals and consumer expectations. Not only is the level of inflation a problem, the speed at which it is easing can also be a problem as long periods of high rates could still cause expectation revisions. Consumer expectations for inflation are around 3.2% based on the Michigan Report, and that's fine for the coming year, but it cannot be allowed to set a new inflation level above the safe 2% target.

The yield curve has shifted up again and that has appropriately erased some of the rally seen in IUSB which has a duration over 6 years, as well as in other longer duration equities, giving up around half of their gains since the lows in November.

Bottom Line

Since there is a structural force that risks the economy if the Fed doesn't risk overshooting with rates, IUSB and other longer duration instruments are a problem. There's also other concerns with IUSB because it's not all AAA rated, and has some lower quality corporate credit. Then there's also the whole debt ceiling issue.

On the other hand, a recession will pull off the demand breaks from inflation, where supply has been the only thing really retreading steps since the beginning of the pandemic, and the majority of the relief. Some suggest that construction declines will bring the economy down once unfinished inventory is exhausted. If this happens, rates aren't going to be going up as much as they might have. However, permitting rates, which involve larger scale renovation and newbuilds, could be much worse considering that there's still a backlog situation in housing, and this indicates construction could be doing worse given everything.

However, on top of other countries' reopening likely to reflate some commodity markets, the structural risks in the economy to do with inflation, which is an extraordinarily pernicious and networked force, tips the balance in favor of caution on longer-duration instruments with quite a margin.

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