The US Fed in its statement last week said it hasn’t decided on an interest rate-hike yet, but Rick Reider, CIO of fixed income at BlackRock thinks the timing doesn’t matter. The market is incessantly focused if lift-off is going to be June or September.
However, there are two other factors that would determine the timing; one: the pace at which the Fed starts to move and two; the destination they are going to. They are likely to be deliberate and the destination (target rate) would be lower than what it has been historically. With the European Central Bank going ahead with Quantitative Easing, rates are expected to remain stable, and the Fed should move when they are ready to go, he noted.
The nonfarm payrolls report is due next Friday. NFP has been pretty much the only positive data-point for the economy amidst a steady stream of soft data that has pushed down 10-year yields below 2 percent. Asked why the payrolls data would still be the determinant, Rick said investors should consider the first-quarter economic data from a wider perspective.
Firstly, there was the weather effect – similar to what was witnessed last year. Then there was a port shutdown in California. There have been seasonal variations over the last few years in the first quarter data. The data is likely to improve as the economy moves forward into the second quarter.
The other important factor is the strong growth-rate in payrolls. Compared to where the economy was five years ago – the economy was growing without a steady job-growth, that situation has been completely reversed. The economy created two million jobs in the last seven months, which is a tremendous achievement that helped bring down the unemployment rate to 5.5 percent.
Some of the job growth is surely a catch-up to what happened a few years ago and the Fed has an open window to move, he explained.
The latest GDP data showed corporate profits slumped to the lowest in several years. Asked to explain, Rick said there were a few factors at play and there’s no doubt the strong dollar has affected corporate profits recently.
Also, there’s no question that some of the recent economic data has been softer than expected, particularly when there have been such tremendous data over the last few quarters and companies have pulled-back. But that should not concern investors much since the dollar’s strength is likely to be fleeting, he observed.
The Fed Funds Futures Rate shows markets are pricing in a 10 percent chance of a rate hike in June. Asked to explain, Rick said while the base case for a lift-off remains September, a rate-hike in June is still possible if monthly numbers rebound strongly. Fed’s vice-chairman Fischer has been pretty clear the hike could come either in June or September. While investors should assume the base case as September, it’d be difficult to take June off the table completely though the bar is higher for a June lift-off at this point in time, he argued.
Corporate debt issuance has shot up and hit a record high with total borrowings touching $290 billion so far this year. Asked if investors should lap-up new papers or stand on the sidelines because if yields move up in near future, prices would move the other way, Rick said when the central bank keeps rate low for such a long time, it allows companies to keep borrowing.
That functionally transfers money from savers to borrowers, which made sense a couple of years ago. Some of the levels seen today, particularly in the investment-grade papers segment, some of the papers have become fairly rich (over-priced). But parts of the high-yield (junk bonds) market are attractive. When rates remain low for so long, a lot of interest rate sensitivity is forced into the markets, into investors. BlackRock likes to take risks in the high-yield and commercial mortgages market – where some of the mortgage exposure is parts of Europe. But there’s no doubt companies are financing at incredibly attractive rates, he noted.
The defining factors so far this year have been a stronger US dollar, but weak commodities along with weak bonds and equities. Asked if that’s likely to continue for the rest of the year, Rick said while there’s no denying that the dollar had been strong so far this year, the Fed tried to introduce a two-way dynamic in the dollar. The greenback is likely to remain strong because of the improvement in trade deficit number readings. In October, the Fed was more dovish and the markets had a hard-time; but they turned hawkish by the end of October. The Fed is likely to introduce a bit of uncertainty into the markets in the coming months, he concluded.
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