All About That Pace and More of My Favorite Themes Jeffrey Rosenberg Chief Investment Strategist for Fixed Income

Transcription

1 All About That Pace and More of My Favorite Themes Jeffrey Rosenberg Chief Investment Strategist for Fixed Income October 2015

2 My Favorite Themes All About That Pace You Don t Have to Live Like a Refugee Shorten Your Duration, But Don t Own Short Duration The Conundrum in the Conundrum Promises, Promises Why Do I Believe? History Doesn t Repeat Itself, But It Rhymes What s in Your Model? Won t Get Fooled Again You Can Lead a Horse to Liquidity But You Can t Make Him Borrow Like a Rolling Loan The Five Stages of Greece and The Dukes of Moral Hazard 2

3 Investment Themes and Recommendations Themes All About That Pace Shorten your duration, but don't own Short D The Conundrum in the Conundrum You Don t Have to Live Like a Refugee History doesn t repeat itself, but it does rhyme The Five Stages of Greece Commodities, Inflation and TIPs Recommendations Treasuries: Our lead theme captures the critical inflection point for all markets: after six years of ZIRP, the Fed is normalizing. We overweight the belly and underweight the wings. Volatility: If ZIRP and QE were intended to lead investors out the risk spectrum in pursuit of higher yields, we should expect greater financial market volatility in 2015 than in past years. Mortgages: Higher interest rate volatility, rising rates concentrated in the front end of the curve, stretched valuations and potential new supply and prepayments move MBS to an underweight. Short Duration: The policy support underlining short duration s past success is now coming to an end. Move up in credit quality or out in favor of a barbell of ultra-short and intermediate exposures. Long Duration: The Fed views the surprisingly small increase in LT yields during the cycle as a mistake that set in motion the GFC. This makes a repeat of 2014 s long-end returns unlikely. Income Surrogates: More likely a second-half 15 theme, rising interest rates may challenge the performance of equity income surrogates. Corporates: In 2014, we advocated balancing credit and interest rate risks. We continue to hold those views as credit no longer functions as the preferred vehicle for bond investing. HY and Loans: The credit cycle has turned, though accumulated liquidity defers actual defaults into We recommend only tactical investments in 2015 and are underweight going into FOMC. Emerging Markets: We hold a tactical underweight but favor high-quality currency hedged local EM (e.g. Mexico, India and Korea). A rising dollar will be a negative for unhedged US investors. Securitized Assets: Buffered by continued accommodative Fed policy (normalization is not tightening) and exposure to U.S. expansion, CMBS/ABS should continue to outperform Non-USD: Sovereign QE expectations are already reflected in the form of tight peripheral and corporate spreads. An ECB announcement may be the time to fade the compression theme. TIPs: A stable oil price will clear the way for modestly higher inflation. However, given the continued volatility in oil prices, breakeven strategies are currently a neutral view. 3

4 Federal Funds Rate (%) All About That Pace Market vs. Fed Normalization Pace bps bps bps bps Dec 2015 Dec 2016 Dec 2017 Long Term Market Expected Pace Fed Indicated Pace Source: JP Morgan, Federal Reserve. As of 9/7/

5 All About That Pace Hawks and Doves Percent Midpoint of target range for the Fed Funds Rate Year End 2016 Hawkish Harker, Kaplan 1 George Powell, Lacker, Bullard, Mester Fischer, Tarullo, Williams Yellen, Brainard, Dudley, Lockhart Rosengren, Kocherlakota Evans Dovish Note: Richard Fisher retired on March 19 th, 2015 and was recently replaced by Robert Kaplan. His views on monetary policy are still unknown, and his dot is currently represented by the previous hawkish stance taken by Fisher and his substitute. Source: JP Morgan, Federal Reserve, BlackRock estimates. 5

6 ECI Wages and Salaries YoY (%) Unemployment Rate (%) Further Improvement in the Labor Market Wage Growth is a Key Indicator of Remaining Labor Market Slack ECI Unemployment Rate (RHS) Source: BLS. 6

7 Mar-97 Oct-97 May-98 Dec-98 Jul-99 Feb-00 Sep-00 Apr-01 Nov-01 Jun-02 Jan-03 Aug-03 Mar-04 Oct-04 May-05 Dec-05 Jul-06 Feb-07 Sep-07 Apr-08 Nov-08 Jun-09 Jan-10 Aug-10 Mar-11 Oct-11 May-12 Dec-12 Jul-13 Feb-14 Sep-14 Apr-15 YoY Change (%) Unemployment Rate (%) Further Improvement in the Labor Market continued Most Recent Trends Show Mixed Picture on Wage Growth ECI: Wages and Salaries: Private Industry Workers ECI: Wages and Salaries: Private Industry Workers ex Incentives Average Hourly Earnings: Production and Non-Supervisory Atlanta Fed Wage Tracker U3 Unemployment Rate Source: BLS, Atlanta Fed. 7

8 % Mind the Gap Demographically Adjusting the Employment-Population Ratio Demographically Adjusted E/P Actual E/P Source: New York Fed. 8

9 Real ECI Wage Growth (%) Further Improvement in the Labor Market continued (again) Real Wage Pressures Increase After E/P Gap is Closed Demographically Adjusted Employee / Population Gap Historical Q Poly. (Historical) Source: New York Fed. Notes: The E/P gap is the difference between the demographically adjusted E/P ratio and the actual E/P ratio. The wage measures are the yearly wage growth rates less the 10-year expected inflation and productivity return, from the BLS and Current Employment Statistics. 9

10 Real Fed Funds Rate What is Normal? Real Fed Funds vs. Recessions NBER Recession Source: Bloomberg; Realized inflation represented by Core CPI Urban Consumers % change year over year. 10

11 Real Fed Funds Rate Distribution From Highly Accommodative to (Merely) Accommodative Real Fed Funds Historical Distribution 25% Highly Accommodative Accommodative Neutral Tight 20% 15% 10% 5% 0% < -2% -2% -1% 0% 1% 2% 3% 4% > 5% Real Fed Funds Rate (%) Source: Bloomberg; Realized inflation represented by Core CPI Urban Consumers % change year over year. 11

12 s10s Curve (bps) Fed Funds Target Rate (%) Yield Curve Flattens as the Fed Moves to Tighten 2s/10s Curve vs. the Fed Funds Rate s/10s Curve Fed Funds Target Rate Source: Bloomberg. 12

13 Brent Crude ($ per barrel) 5y Breakeven (%) Stabilization in Energy Prices Future Inflation Expectations Track Oil Prices and the Fed Brent Crude Oil 5y Inflation Breakeven (RHS) Source: Bloomberg. 13

14 Jan-11 Mar-11 May-11 Jul-11 Sep-11 Nov-11 Jan-12 Mar-12 May-12 Jul-12 Sep-12 Nov-12 Jan-13 Mar-13 May-13 Jul-13 Sep-13 Nov-13 Jan-14 Mar-14 May-14 Jul-14 Sep-14 Nov-14 Jan-15 Mar-15 May-15 Jul-15 Commodity Price (Indexed to 100 as of Jan. 2010) Citi Li Keqiang Index (YoY %) The Emperor Has No Clothes Commodity Prices Track China Growth Outlook Iron - 62% Fe CFR China LME 3M Copper Citi Li Keqiang Index (YoY % Change) Source: Bloomberg, Citigroup Li Keqiang Index V 2.0 The Chinese premier, Li Keqiang, has reportedly preferred to use three indicators railroad cargo volume, electricity consumption and bank lending, as both timelier and more accurate indicators of Chinese growth than GDP. 14

15 DM Credit (% of GDP) EM Credit (% of GDP) Small Forest Fires Prevent Large Forest Fires The Accumulated Fuel in Emerging Markets Private DM Credit Private EM Credit (RHS) Private EM Credit ex China (RHS) Source: J.P. Morgan. 15

16 $ in bn (4Q Moving Average) The Big Fear China Capital Outflows Current Account Change in Reserves FDI + Portfolio Flows Other Investment Source: Haver Analytics. 16

17 Household Net Worth as a % of Personal Disposable Income Savings Rate (%) The Fed s Absolution (for Original Sin) US Wealth vs. Savings Rate Household Net Worth as a % of Personal Disposable Income Savings Rate (RHS) Source: Federal Reserve, BEA. 17

18 Financial Conditions Paradox Stock and Bond Allocations 80% 70% 60% 50% 40% 30% 20% Bonds Equities Source: Federal Reserve Z-1; Assets calculated from the Household, Mutual Fund, Life Insurance and Pension Fund Stock data. 18

19 OAS Price ($ / barrel or tonne) Commodity Risks in Credit High Yield Sector Concentration in Energy (14%) and Metals/Mining (5%) 1, HY Energy HY Metals and Mining WTI Crude Oil (RHS) Iron - 62% Fe CFR to China (RHS) Source: Barclays. HY yields represented by the Barclays US Corporate HY Index. 19

20 Spread to Worst (bps) Trailing 12 Month Default Rate (%) Like a Rolling Loan High Yield Spreads vs. High Yield Default Rates % 16% 14% 12% 10% 8% 6% 4% 2% 0% High Yield STW HY Default Rate Source: JP Morgan, Moody s. HY spreads represented by the Barclays US Corporate HY Index. 20

21 Default Rate (%) Issuance as % of Market Size A Rolling Loan Gathers No Loss High Yield Default Rates vs. Issuance 16% 14% 100% 90% 12% 10% 8% 6% 4% 2% 80% 70% 60% 50% 40% 30% 20% 10% 0% % Default Rate (LHS) Issuance as a % of Market Size (RHS) Source: BAML, Moody s. 21

22 High Yield Price Loan Price Repricing Liquidity and Default Risk Tactical Opportunities in High Yield and Loans HY Price BB/B Loan Price (RHS) Source: Barclays, S&P LCD. HY yields represented by the Barclays US Corporate HY Index. 22

23 The Five Stages of Greece Historical Debt/GDP Ratio Source: Reinhart and Sbrancia The Liquidation of Government Debt NBER Working Paper 16893, March. 23

24 Yield (%) and the Dukes of Moral Hazard ECB Supported Peripheral Bond Spread Tightening "Believe me, it will be enough" Spanish 3 Year Yields Italian 3 Year Yields Source: Bloomberg. 24

25 Gross Debt as % of GDP (% of GNP for Puerto Rico) Gyros and Mofongo Greece and Puerto Rico Debt Trajectories 190% 170% 150% 130% 110% 90% 70% 50% Calendar Year (FY ending June 30th For Puerto Rico) Greece - 1% Primary Surplus Puerto Rico - Non-Reform Case 90% Threshold Greece - Current Proposal Puerto Rico - Reform Case Source: IMF, "Puerto Rico - A Way Forward" by Anne Krueger, Government Development Bank of Puerto Rico, BlackRock estimates. 25

26 Price This Debt is Not Payable Puerto Rico General Obligation and Greek Government Bond Reactions Puerto Rico GO 2035 Greek Govt Bond 2017 Source: Bloomberg. As of 9/8/

27 Jan-12 Apr-12 Jul-12 Oct-12 Jan-13 Apr-13 Jul-13 Oct-13 Jan-14 Apr-14 Jul-14 Oct-14 Jan-15 Apr-15 Jul-15 Jul-14 Aug-14 Sep-14 Oct-14 Nov-14 Dec-14 Jan-15 Feb-15 Mar-15 Apr-15 May-15 Jun-15 Jul-15 Aug-15 Sep-15 CPI YoY (%) South Korea CPI YoY (%) Mexico and India South Korea EM: High Quality, Local Currency (FX Hedged) Falling Oil Reduces Inflation Risks Creating Room for Policy Accommodation Source: Bloomberg. Mexico India South Korea (RHS) MXN Policy Rate INR Policy Rate KRW Policy Rate MXN 1Y1M INR 1Y1M KRW 1Y1M 27

28 Jan-10 Jun-10 Nov-10 Apr-11 Sep-11 Feb-12 Jul-12 Dec-12 May-13 Oct-13 Mar-14 Aug-14 Jan-15 Jun-15 US 10 Year Yields (%) EM Local Currency Yields (%) JP Morgan EM FX 2 Year Treasury Yield (%) EM: Defensive Ahead of the Fed Local Rates Track US Rates EM FX Risks vs. Fed Policy US 10 Year Treasury Local Currency EM Yields (RHS) EM FX Index 2 Year Treasury (RHS) Source: J.P. Morgan GBI-EM Global Diversified, J.P. Morgan Emerging Market Currency Index, Bloomberg. 28

29 Jan-13 Feb-13 Mar-13 Apr-13 May-13 Jun-13 Jul-13 Aug-13 Sep-13 Oct-13 Nov-13 Dec-13 Jan-14 Feb-14 Mar-14 Apr-14 May-14 Jun-14 Jul-14 Aug-14 Sep-14 Oct-14 Nov-14 Dec-14 Jan-15 Feb-15 Mar-15 Apr-15 May-15 Jun-15 Jul-15 Aug-15 Sep-15 Rolling 20 Day Correlation Interest Rate Volatility (bps) What s in Your Model? Correlation Shift in Summer 2013 and 2015 Corresponded to Rate Uncertainty 100% 80% 60% % 20% 0% -20% -40% -60% -80% -100% Rate and Equity Return Correlation Interest Rate Volatility Source: BAML MOVE Index, Barclays, Bloomberg. 29

30 Spread (bps) Higher Volatility, Greater Prepayment Risk, Tight Spreads = U/W MBS Refis Spike And Spreads are Tight Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Mortgage Bankers Association Refinancing Index FNMA Current Coupon 30 Year Spread Source: Mortgage Bankers Association, Bloomberg. 30

31 3 Key Action Items 1. Manage duration and curve risk in fixed income Utilize FLEXIBLE strategies 2. Rebalance credit and interest rate risks Maintain tactically positioning in Investment Grade, High Yield and Bank Loans (currently underweight) Overweight CMBS; look for flexible positioning in emerging markets (underweight) 3. Overweight the belly and underweight the front end Reduce 2-5 year exposures; implement bond ladders 31

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33 Important notes This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of October 2015 and may change as subsequent conditions vary. The information and opinions contained in this material are derived from proprietary and non-proprietary sources deemed by BlackRock and/or its subsidiaries (together, BlackRock ) to be reliable, are not necessarily all inclusive and are not guaranteed as to accuracy. There is no guarantee that any forecasts made will come to pass. Any investments named within this material may not necessarily be held in any accounts managed by BlackRock. Reliance upon information in this material is at the sole discretion of the reader. Past performance is no guarantee of future results. Reliance upon information in this material is at the sole discretion of the reader. Investment involves risks. 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 are often heightened for investments in emerging/developing markets or smaller capital markets. The information contained in this material is derived from third-party sources deemed reliable, but BlackRock does not guarantee the completeness or accuracy of the information. The two main risks related to fixed income investing are interest rate risk and credit risk. Typically, when interest rates rise, there is a corresponding decline in the market value of bonds. Credit risk refers to the possibility that the issuer of the bond will not be able to make principal and interest payments. Stock and bond values fluctuate in price so the value of your investment can go down depending upon market conditions. Investments in non-investment-grade debt securities ( high-yield bonds or junk bonds ) may be subject to greater market fluctuations and risk of default or loss of income and principal than securities in higher rating categories. Investments in the financial services industry may be susceptible to certain economic, competitive and regulatory developments associated with such industries. BLACKROCK is a registered trademark of BlackRock, Inc. or its subsidiaries in the United States and elsewhere. All other trademarks are the property of their respective owners BlackRock, Inc., All Rights Reserved. 33