The big movements in global interest rates were really about changes in global expectations, particularly around longer term inflation expectations, which is partly related to the turnaround in oil prices and other developments such as shift in expectations for European growth and that’s impacting primarily longer-dated interest rates, said Jeff Rosenberg, chief investment strategist for fixed income at BlackRock.
On the Fed’s side, in shorter-dated interest rates, BlackRock has actually been pushing expectations back since economic data has been weaker than expected and continues to be weak in the first-quarter.
Expectations for first the lift off by the Fed have been pushed out and investors are witnessing a really big steepening in the yield curve with longer-term interest rates going higher and expectations for the Fed has been pushed down that has capped any increase on the shorter maturity interest rates, he observed.
Asked if the assumption by most investors that the economy would rebound after a weak first quarter were correct, Jeff said the April data, particularly the retail sales data, was disappointing.
Weak numbers are certainly going to raise some questions about the expectations that the seasonal patterns, that were witnessed over the last four or five years, would again re-emerge if the economy posts weaker data in the first half of the year followed by strength in the second half.
BlackRock still believes economic strength in the second half will show up as consumption trends, employment strength and rising real wages will all result in a better consumption trend in the second half. But in the short run, markets are going to focus on the disappointing data and that’s what is pushing back some of the Fed expectations, he noted.
European Central Bank President Mario Draghi this week said in Washington the central bank would complete QE in September 2016 provided inflation expectations don’t substantially change. Asked if the markets expect the ECB to blink and discontinue QE, Jeff said Draghi has been very clear that the ECB’s plan will run its course.
The issue for financial markets is that they ran ahead of the curve; the expectations that there would be a potential drop further in deposit rates show the markets got far ahead of the ECB. Part of the shift in European bond markets was recognizing that the growth outlook for Europe wasn’t as bad as was anticipated and the associated deflationary risks weren’t as bad as anticipated. While Draghi is expected to make good on his promise, it’s really the shift in market expectations that are moving around European and global interest rates, he explained.
There have been repeated warnings that the bond markets are over valued and high-yields are due for a crash. Asked to explain opportunities in the fixed income market, Jeff said opportunities are more around flexible strategies for extracting value as it’s tough to buy bonds outright in a low interest rate environment.
But investors can play in different areas of the yield curve; for example, the back-end of the yield curve has been steepening, which makes it very attractive. Also, extracting out inflation expectations from Treasury protected securities has been an attracting play. Taking on global interest rate exposures, but being able to hedge effects of forex risk is another way to invest in fixed income, he concluded.
You can watch the video here.