Fixed Income Highlights

  • "I drink your milkshake!" Daniel Day-Lewis’ most memorable final-scene line from There Will Be Blood (2007) provides a metaphor for directional drilling. Combine directional drilling with hydraulic fracturing and you get the U.S. natural gas and tight oil boom. That boom partly lies behind the collapse in oil prices, bringing with it the "blood" of collapsing energy-related investments. To wit, the energy sector in high yield stands down more than 10% since the end of June, mirroring its equity counterpart S&P500 Energy sector, down over 20%. For fixed income investors we highlight three key consequences: a consumption "tax cut" boost, a divergent impact on emerging markets of winners and losers and a tail risk to high yield.
  • Return to the O.C. Nope, that is not a reference to a new Orange County reality TV show but to "Optimal Control," the Fed’s preferred tool for monetary policy making. A recent Fed staff paper suggests that the OC-prescribed path for interest rates argues for liftoff now. Why should any of this inside monetary policy baseball matter? Because the OC framework provided much of the intellectual justification behind the market’s belief in "low for longer." Count the "OC" indicating liftoff from zero rates, along with recent comments by NY Federal Reserve Bank President William Dudley and vice-Chair Stanley Fischer, as further evidence arguing for a faster liftoff from zero rates than is currently priced by short-term interest rates. December’s Federal Open Market Committee statement later this month will cap that view. Excising the "considerable period" language will set the market on course for a June liftoff from zero interest rates, making the shorter maturity segment of the bond market the most vulnerable to higher interest rates.
  • How I Stopped Worrying and Learned to Love the Bond, Reviewed (our annual review of 2014’s My Favorite Themes and fixed income performance). Like so many years before (with the one exception of 2013), predictions of rising rates again flummoxed the "experts." Our view that "where you hold your duration matters as much as how much duration you hold" helped to mitigate that error as we emphasized longer maturities whose performance in 2014 topped all categories. A more tactical allocation "rebalancing credit and interest rate risks" also proved correct, as more variability in credit returns previews a more challenging environment for credit in 2015. Dollar strength undermined global fixed income performance (for dollar-based investors) as our call for a stronger dollar vs. foreign currencies was supported by the now prevalent viewpoint of "divergences." That latter theme features prominently in the outlook for 2015, a topic we’ll address in more detail in early January.

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What to Know—and Do—in 2015

THE BLACKROCK LIST
As the calendar turns to 2015, it's time to assess the investing landscape and your investment portfolio to ensure you're well positioned for the New Year. The List can help.

The sector performance and yields listed are represented by, respectively: Barclays US High Yield Index, S&P Leveraged Loan Index, Barclays US Securitized Ex-MBS Index, Barclays US Mortgage Backed Securities Index, Barclays US Corporate Investment Grade Index, Barclays Global Aggregate ex-USD Index, JP Morgan EMBI Global Diversified Index, Barclays US Inflation Protected Securities Index and Barclays US Treasury Index. The reference indices are represented by the Barclays US Aggregate and the Barclays Municipal Bond Index.

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.

Non-investment-grade debt securities (high-yield/junk bonds) may be subject to greater market fluctuations, risk of default or loss of income and principal than higher-rated securities.

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, in concentrations of single countries or smaller capital markets.

Index performance is shown for illustrative purposes only. You cannot invest directly in an index.

The opinions expressed are those of BlackRock as of November 4, 2014, and may change as subsequent conditions vary. Information and opinions are derived from proprietary and nonproprietary sources deemed by BlackRock to be reliable. The information contained in this report is not necessarily all-inclusive and is not guaranteed as to accuracy. Past performance does not guarantee future results. There is no guarantee that any forecasts made will come to pass. This material does not constitute investment advice and is not intended as an endorsement of any specific investment. Investment involves risk. Reliance upon information in this report is at the sole discretion of the reader.

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