Managing Director

Jeffrey is BlackRock’s Chief Investment Strategist for Fixed Income. Prior to joining BlackRock, he spent nearly a decade at Bank of America Merrill Lynch as Chief Credit Strategist, focusing most recently on fixed income, securitized assets, credit, FX and commodities strategies. He is a CFA charterholder and writes about fixed income markets.

Latest posts from the contributor

January 26, 2015

As resolutions go, rethinking your fixed-income portfolio may not resonate in quite the same way as dropping 10 pounds or finally giving up that smoking habit. But if ever there was an opportunity to reassess how you approach bond investing, now is the perfect time.

Last year our lead theme of How I Stopped Worrying and Learned to Love the Bond favoring longer-maturity debt was right, even if for the wrong reasons. We thought rates would go up but long bonds would outperform; the latter was correct but the former clearly was not. This year our lead theme All About That Pace again appears out of consensus as the market view for rates has shifted towards fears of deflation and expectations that low global rates means U.S. rates can never move higher. The latter part of the year also brought plenty of financial-market volatility—a trend that is likely to continue in 2015. If persistent zero interest rates and quantitative easing that were intended to lead investors to take more risk in pursuit of higher yielding assets led to dampened volatility, we should expect greater financial market volatility in 2015 as the Fed pulls back from its zero rate policy.

It’s partly because of that volatility that fixed-income investors need to reassess their commitment to bonds. Always keep in mind what role bonds play in your portfolio:

1. Diversification. Use traditional bond strategies to diversify equity exposure.

1. Source of Protection. Use flexible bond strategies to guard against interest rate and credit events.

1. Income. Use yield-focused solutions to help generate income.

The benign environment of the past six years has bred complacency in investments expected to have the least amount of risk. This is particularly the case for bonds that, in today’s zero interest rate environment, have commonly been used as surrogates for cash. That complacency should now be challenged if the outlook that the Fed is finally going to raise rates is realized. Our shorten your duration but don’t own short duration theme captures this idea. Higher yielding strategies have been rewarded in the past, but those yields result from greater interest rate or credit/illiquidity risk, or both.

While reaching for yield has been successful in the past, we suggest increasing credit quality, increasing liquidity and reducing risk in an environment where the Fed’s policy changes introduce a very different forward-looking outlook. That different outlook is captured in the figure nearby highlighting how the downside risks to bonds—in this case looking at short duration bonds—is masked in an era of zero interest rate policy but is revealed when the Fed begins raising rates.

No Longer a Cash Alternative: Risks in Short Duration Expand During Hiking Cycles

Also keep in mind that flexible bond strategies have the potential to outperform in rising and flat interest rate environments, and can help provide meaningful diversification, which may reduce overall volatility in a portfolio. Their greater flexibility allows the implementation of many of our key outlooks this year: yields that move in very different ways depending on the maturity, as front end rates lead higher rates from Fed policy changes, but back end rates look vulnerable from overpricing fears of deflation. Decoupling bonds from their currency risk in Emerging Markets as well represents another favored strategy that flexible bond strategies can employ to help investors navigate a more volatile investment environment in 2015.

When the Fed does raise rates—and we expect that in June—then the largest impact will be felt in the shortest maturity yields. The historical record shows that even though this should not be any “news” to anyone, the bond market inevitably tends to overreact. The result is an increase in short-term interest rates beyond what is currently reflected in market expectations and the consensus view, leaving our 2-year forecast a bit higher at 1.75%.

And higher short-term interest rates is one reason we disagree with market consensus concluding that a world of low interest rates means the 10-year can never rise. We believe that when the Fed starts raising rates in the front end it will want to see long-end rates rise as well. This is to both avoid over stimulating the housing market (a mistake they now admit occurred during the last cycle) and to avoid the negative signal of inverting the yield curve. And though the market may have forgotten it, the Fed has $4.5 trillion reasons to make sure that outcome occurs. That leaves us expecting modest increases in the 10 year rate to 2.5% for year-end 2015.

Jeffrey Rosenberg, Managing Director, is BlackRock’s Chief Investment Strategist for Fixed Income, and a regular contributor to  The Blog.  You can find more of his posts  here.

The opinions expressed are those of Jeffrey Rosenberg as of 1/25/2014 and are subject to change at any time due to changes in market or economic conditions. The comments should not be construed as a recommendation of any individual holdings or market sectors.

Investing involves risk, including possible loss of principal.

Fixed income risks include interest-rate and credit risk. Typically, when interest rates rise, there is a corresponding decline in bond values. Credit risk refers to the possibility that the bond issuer will not be able to make principal and interest payments.  International investing involves risks, including risks related to foreign currency, limited liquidity, less government regulation and the possibility of substantial volatility due to adverse political, economic or other developments. These risks often are heightened for investments in emerging/developing markets and in concentrations of single countries. 

This material represents an assessment of the market environment at a specific time and is not intended to be a forecast of future events or a guarantee of future results. This information should not be relied upon by the reader as research or investment advice regarding the funds or any security in particular.

©2015 BlackRock, Inc. All rights reserved.  iSHARES  and  BLACKROCK  are registered trademarks of BlackRock, Inc. or its subsidiaries. All other marks are the property of their respective owners.

USR-5392

January 23, 2015

The European Central Bank on Thursday delivered­ basically what the market expected for QE: 60 billion euros of purchases per month directed at investment-grade -rated government and agency debt and with a total size, considering the contemplated end date by September 2016, of around one trillion euros. The modest decline in the euro and further declines in European bond yields, along with compression between peripheral and core bonds, all reflect the success of a QE announcement in line with market expectations.

Importantly─and with the usual caveats of smaller market liquidity─inflation expectations signaled from inflation-linked bonds and the ECB’s oft cited five year, five-year forward measure of inflation increased on the day. That trend towards higher inflation expectations continued into U.S. inflation expectations, indicating that the ECB QE announcement, and coincident with tentative signs of stabilization of oil prices, may mark the low point of deflationary fears driving global interest rates to new lows.

The surprises, if any, were to be found in Draghis Q&A session and in his more off-scripted moments. We consider two to be critical.

1.  The maturity range of purchases. Having not been laid out in the prepared remarks, Draghi answered this question most casually. But as can be seen by the chart below, the casual extension of purchases out to 30 years appears not to have been the market expectation, as the clarification led to the most dramatic of market moves associated with the QE announcement.

This turnabout also appears to have turned overall yield sentiment. Whereas the initial reaction to the 60-billion-euros-a-month announcement of higher yields might have reflected some disappointment, Draghis clarification on maturity reversed that interpretation, leading to lower rates across the curve, the continent and spilling over into all global bond markets.

2.  Clarification of whether the plan will work. We found the candid remarks to a question by Brian Blackstone of The Wall Street Journal to be a crucial interchange. Blackstone asked why the financial markets should think the plan will work in terms of boosting inflation and restoring economic growth and employment in the eurozone. Draghi offered a handful of reasons, but also noted that while monetary policy can build the foundation for growth, it’s up to government policy to implement vital structural reforms. a point he has stressed on many occasions.

As we highlighted in our 2015 outlook piece. there are significant differences between how we should expect QE to benefit the real economy in Europe relative to how it benefited the economy in the U.S. In the latter case, the benefits from what Draghi called substitution (and what the Fed calls the Portfolio Rebalance Channel) are limited to just the lending impacts he describes. As such it is hard to imagine, given the ample liquidity support and incredibly low (and negative) interest rates already entrenched in Europe, how expanding QE will lead to further real economy benefits from this channel. In the U.S. those further benefits crucially flowed through the wealth effect channel: substitution of lower risk assets such as bank deposits and Treasuries for high yield bonds and equities led to price increases in those risky assets. That broad based asset inflation, including critically the intended recipient house price inflation, led to rising consumption, a pattern well entrenched in the U.S. economy.

Such a relationship has no basis in the European economy (and as we pointed out in our outlook piece, in the case of Germany actually shows some evidence of the opposite of the intended effect, as rising wealth is associated with rising savings rates and reduced consumption). Hence the main and, per Draghi, unintended transmission mechanism to the real economy lies in the currency. Since it’s unacceptable for global central bankers to directly target the currency as a policy tool, Draghi refers to the currency impacts as effects of the policy, not targets.

That leaves fiscal policy and structural reforms as the critical and necessary next steps to support economic recovery in Europe. But those steps require political will and hard and risky choices for democratically elected leaders facing an increasingly euro-skeptical and polarized electorate. Which brings us to the ECBs QE paradox: in such a political environment, only significant market or economic pressure can bring governments to make such difficult decisions. A clear mandate of governing majority is required to undergo such a politically fraught exercise. Even in the case of Japan, where arguably Abe has such a political opportunity, he still faces entrenched opposition to imposing his third arrow structural reforms .

Todays low public opinion of Europes governments suggests few would or could be expected to follow this path. And absent the bond market pressure that Draghi has so successfully done whatever it takes to ensure it never to return, the very action of QE reduces the likelihood of governments undertaking the reforms Draghi so repeatedly calls on them to take.

Jeffrey Rosenberg, Managing Director, is BlackRock’s Chief Investment Strategist for Fixed Income, and a regular contributor to  The Blog.  You can find more of his posts  here.

The opinions expressed are those of Jeffrey Rosenberg as of 1/23/2014 and are subject to change at any time due to changes in market or economic conditions. The comments should not be construed as a recommendation of any individual holdings or market sectors.

Investing involves risk, including possible loss of principal.

This material represents an assessment of the market environment at a specific time and is not intended to be a forecast of future events or a guarantee of future results. This information should not be relied upon by the reader as research or investment advice regarding the funds or any security in particular.

©2015 BlackRock, Inc. All rights reserved. iSHARES and BLACKROCK are registered trademarks of BlackRock, Inc. or its subsidiaries. All other marks are the property of their respective owners.   USR-5404

November 13, 2014

The sharp, greater-than-20% drop in crude oil prices from its highs in June reflects dramatic changes in the marginal supply of oil, shifting expectations for demand and, critically, a change in the outlook for monetary policy. The resulting stronger dollar is weakening its equivalent measure in the price of oil. As my colleague Russ Koesterich points out in a recent post. this trend has produced some unexpected winners.  Today, I’m going to go a step further to explore why oil prices have declined and what this means for the economy.

 The Reasons Behind the Decline

The drop in crude oil prices can be attributed to three simple reasons— demand, supply and the dollar. On the demand side, a downgrade in the IMF’s global growth forecast for 2015 in early October coincided with continued eurozone weakness, punctuated by very weak German manufacturing data for August and an un-anchoring of long-term inflation expectations. Furthermore, the latest economic data from Japan showed an economy struggling to cope with the consumption tax implemented in April, with a large drop in GDP and consumer spending. And over the summer, China oil consumption disappointed, even above that expected along with its declining growth.

On the supply side, the long-run U.S. shale oil renaissance has helped propel U.S. crude oil production from a low of about 5 million barrels per day in the mid-2000s to a 30-year high of about 8.7 million barrels per day. This structural trend intersected a series of positive supply developments over the last three months, including airstrikes against ISIS, the re-opening of Libyan ports, the fading of risks surrounding Russian oil supply and increasing Iranian shipments. Finally, Saudi Arabia signaled that it would no longer act as the marginal producer of oil, and instead committed to maintaining market share.

Another important relationship is that with the dollar. Commodities such as oil are dollar denominated and oil can be viewed as another store of value, much like gold or FX. As the dollar strengthens, the value of oil relative to the dollar falls. The correlation between changes in the U.S. dollar and oil prices has been quite strong historically (see chart below), and indeed, the fall in crude oil prices has coincided with the strength of the dollar, strength that reflects stronger relative U.S. economic performance.

US Dollar vs. Brent Crude Oil Prices

Economic Impact

On net, the winners from lower oil prices outweigh the losers. In particular, the largest beneficiaries to growth are from consumption, as lower gas prices free up more disposable income for, say, holiday shopping. With a $30 drop in oil prices since August, this would add an estimated 0.2% to 0.5% to GDP from personal consumption. The impact will be felt most by the lowest income households where the additional income will have a disproportionate impact. Estimates of about a 10% decrease in capital expenditures as the energy sector reassesses economic feasibility of projects would only create a drag of about 0.1% on GDP. However, for investments in specific energy-related sectors (or emerging markets where energy or other commodity related investment represents a larger percentage of exposures), greater care will need to be exercised in looking at the specific sectoral impact.

In high yield bonds. for example, significant new investments have been made in shale gas and oil investments. Such growth in investments, fueled by debt and reflected in the significant rise in the energy sector weightings, as well as the number of new issuers, could represent significant sources of future risk. That risk, of course, depends on where oil prices ultimately stabilize.

Jeffrey Rosenberg, Managing Director, is BlackRock’s Chief Investment Strategist for Fixed Income, and a regular contributor to  The Blog.  You can find more of his posts  here.

This material represents an assessment of the market environment at a specific time and is not intended to be a forecast of future events or a guarantee of future results. This information should not be relied upon by the reader as research or investment advice regarding the funds or any security in particular.

©2014 BlackRock, Inc. All rights reserved. iSHARES and BLACKROCK are registered trademarks of BlackRock, Inc. or its subsidiaries. All other marks are the property of their respective owners.