Bonds as ballast

BlackRock |15-May-2019

Building portfolio resilience is crucial at a time of elevated macro uncertainty. Relatively muted cross-asset volatility suggests markets are not fully pricing in heightened geopolitical risks that threaten to weaken economic activity. We believe central banks’ dovish pivot is buying investors time to add resilience to portfolios – with government bonds playing an important role in providing ballast.


Sources of income
Yields across various fixed income markets, 2015-2019

Yields across various fixed income markets, 2015-2019

Past performance is not a reliable indicator of current or future results. It is not possible to invest directly in an index.
Sources: BlackRock Investment Institute, with data from Thomson Reuters, May 2019. Notes: The lines show the yield of the following bond indexes at various points in time. Indexes used are the Bloomberg Barclays Global Aggregate Index, Bloomberg Barclays US Aggregate Index, Bloomberg Barclays US Corporate High Yield Index and the Bloomberg Barclays Emerging Market (EM) USD Aggregate Index. Indexes are unmanaged and not subject to fees.

  • Themes: A patient Fed – and a dovish tilt to monetary policy globally – should give comfort to investors in search of income. This is reflected in our upgrade (for fixed income only portfolios) of several credit sectors. See the Views tab. Yields are higher across global bond markets versus two years ago, offering greater income potential. See the chart above. Overall, we see a narrow path ahead for risk assets to move higher – but there are risks that could knock markets off track. US Treasuries have historically played a key role in cushioning portfolios against such bouts of volatility.
  • Central banks: The big debate for the next couple of quarters: whether the Fed is pausing rate hikes or if rates have already peaked. Our take: Rates are on hold for the time being. The Fed may also allow inflation to run hotter, as it considers a change (unlikely for now, in our view) to its inflation targeting framework. We expect the European Central Bank to pause further steps toward policy normalization for 2019 and beyond, as it seeks to ensure a return of inflation. We believe the Bank of Japan may tweak policy earlier than markets expect, in an effort to improve the sustainability of its “yield curve control” policy.
  • Growth and inflation: Our BlackRock GPS indicates that the global expansion should continue through the year, albeit with global growth moderating further. We see US growth slowing as the economic cycle moves into the late stage. We expect European growth to find firmer footing later this year (read our recent Macro and market perspectives), but worry about the ECB’s lack of policy levers to counter any future downturn. We are increasingly confident the Chinese economy will turnaround in the second quarter, fueled by fiscal and monetary policy easing. Global inflationary pressures remain subdued, particularly in the eurozone and Japan.
  • Risks: We believe the US economy can remain in the late-cycle phase, avoiding recession throughout 2019. We see little sign of economic overheating or inflationary pressures. A resurgence of recession fears or inflation pressures that force the Fed to resume tightening pose risks to our outlook, as detailed in our Q2 2019 Global investment outlook. Other risks include an intensification of US-China trade disputes or a US-Europe trade showdown. Read more about key risks on our BlackRock geopolitical risk dashboard.

Fixed income views

Our views are from a US dollar perspective over a three-month horizon. Views and comments are from a fixed income-only perspective, and may differ from whole-portfolio tactical views on fixed income in our Global weekly commentary. For example, we overweight US credit and emerging market debt from a fixed income perspective because of their income potential. Yet we are neutral on these asset classes in a multi-asset context, where we prefer to take economic risk in equities. Views are as of May 1.


Rates View Comments
US government bonds icon-neutral We are cautious on US Treasury valuations after the recent rally, but still see the bonds as important portfolio diversifiers given the traditional inverse relationship between US equity and government bond returns. We see recent moves as excessive and advocate patience before increasing exposure. We prefer shorter dated bonds and expect a gradual steepening of the yield curve, driven by still-solid US growth and the Fed’s stated willingness to tolerate inflation overshoots.
US inflation protected icon-up We prefer allocations to inflation-protected securities amid a slowing but growing economy, the likelihood of a steeper yield curve and potential for higher market-based inflation expectations. The Fed has confirmed its intent to be patient with its next rate move and may let inflation temporarily breach its 2% target. We see inflation-protected securities as an attractive alternative to nominal bonds.
US agency mortgages icon-down We are underweight the asset class in the near term, following recent outperformance by current-coupon mortgages against other asset classes — especially in risk-adjusted terms. We do see opportunities in high-coupon mortgages or specified pools.
US municipal bonds icon-up We expect coupon-like returns amid favorable supply-demand dynamics and a benign interest rate backdrop. New issuance is lagging the amount of debt that is called, refunded or matures. The tax overhaul has made munis’ tax-exempt status more attractive in many US states, driving inflows. Munis also generally display less sensitivity to rate moves.
Global rates ex US icon-neutral We have upgraded our view to neutral from underweight. European sovereign bonds offer an attractive income opportunity for US-dollar based investors on a currency-hedged basis. In the near term, we expect the European Central Bank will remain accommodative and further dampen volatility in the European bond markets. Any further deterioration in US-European trade tensions could push European sovereign yields lower.


Credit and other View Comments
US investment grade icon-up We see three themes for this asset class in 2019: more attractive valuations, opportunities in BBB bonds and the importance of security selection given recent volatility. We prefer an up-in-quality stance overall, but recent spread widening has cheapened valuations and may also offer an attractive opportunity in BBB-rated credits. Increased demand for income amid stable monetary policy, signs of more conservative corporate behavior and constrained supply remain supportive for the asset class.
US high yield icon-up We like the asset class for its income potential. We see generally healthy corporate fundamentals, supportive supply-demand, and the rally in credit markets during the first quarter places current valuations near our estimate for fair value. Weaker earnings growth in 2019 relative to consensus estimates may inject volatility into credit markets, but we view this as an opportunity to add value through credit selection.
US bank loans icon-neutral We have upgraded our view to neutral from underweight. We view bank loans as an attractive source of high-quality income, and their floating-rate nature can potentially provide a cushion against rising rates. Demand for bank loans may be challenged in the near term, but lower loan supply is an offset. We prefer balanced exposures across the quality spectrum and advocate a selective approach in market pockets where deteriorating credit quality is concentrated — such as in “loan only” and smaller capital structures.
US securitized assets icon-up We like securitized assets for their relatively attractive yields and income potential, as well as their stability and diversified credit exposure. We favour a diversified approach that balances allocation to residential and commercial mortgage backed securities (RMBS and CMBS), collateralized loan obligations (CLOs) and whole loans, as well as asset-backed securities (ABS).
Euro investment grade icon-neutral We have upgraded our view to neutral from underweight. “Low for longer” ECB policy as well as recent weak economic news should reduce market volatility and support the asset class. European bank fundamentals now appear in decent shape with sufficient capital levels, after years of de-risking and repairing balance sheets. We see attractive relative value and income potential in BBB bonds over the near term.
Euro high yield icon-up We have upgraded our view to overweight from neutral. We see European high yield supported by muted issuance and strong inflows. Valuations have risen a decent amount since the beginning of the year, yet still look attractive amid slowing economic growth and limited default risk. Euro high yield also offers a significant spread premium to US counterparts. For global investors, we see the additional yield offered from a currency-hedged exposure back to US dollars as attractive.
Emerging market debt icon-up Prospects for a turnaround in Chinese growth and a pause in US dollar strength support both local- and hard-currency markets. Valuations appear attractive to us despite the recent rally, with limited new issuance adding to the positives. Risks include further deterioration in US-China relations and slower global growth.
Asia fixed income icon-up We favor investment grade in India, China and parts of the Middle East, and high yield in Indonesia. Portfolio rebalancing could cause material capital inflows into China from other countries, as China’s opens its markets to foreign capital and Chinese assets get included in international bond and equity indices. We are cautious on Chinese government debt despite its inclusion in global indexes from April.

icon-up Overweight icon-neutral Neutral icon-down Underweight

Scott Thiel
Chief Fixed Income Strategist
Scott Thiel, Managing Director, is Chief Fixed Income Strategist for BlackRock and a member of the BlackRock Investment Institute (BII).

General Disclosure: 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 May 2019 and may change. The information and opinions are derived from proprietary and non-proprietary sources deemed by BlackRock to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by BlackRock, its officers, employees or agents. This material may contain ’forward looking’ information that is not purely historical in nature. Such information may include, among other things, projections and forecasts. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this material is at the sole discretion of the reader.

In the US, this material is intended for public distribution. In Canada, this material is intended for permitted clients only. In the UK and outside the EEA: This material is for distribution to professional clients (as defined by the Financial Conduct Authority or MiFID Rules) and qualified investors only and should not be relied upon by any other persons. Issued by BlackRock Investment Management (UK) Limited, authorised and regulated by the Financial Conduct Authority. Registered office: 12 Throgmorton Avenue, London, EC2N 2DL. Tel: 020 7743 3000. Registered in England No. 2020394. BlackRock is a trading name of BlackRock Investment Management (UK) Limited. In the EEA, it is issued by BlackRock (Netherlands) BV: Amstelplein 1, 1096 HA, Amsterdam, Tel: 020 – 549 5200, Trade Register No. 17068311. BlackRock is a trading name of BlackRock (Netherlands) B.V. For qualified investors in Switzerland, this material shall be exclusively made available to, and directed at, qualified investors as defined in the Swiss Collective Investment Schemes Act of 23 June 2006, as amended. In South Africa, please be advised that BlackRock Investment Management (UK) Limited is an authorised financial services provider with the South African Financial Services Board, FSP No. 43288. In DIFC: This information can be distributed in and from the Dubai International Financial Centre (DIFC) by BlackRock Advisors (UK) Limited — Dubai Branch which is regulated by the Dubai Financial Services Authority (DFSA) and is only directed at 'Professional Clients’ and no other person should rely upon the information contained within it. Neither the DFSA or any other authority or regulator located in the GCC or MENA region has approved this information. This information and associated materials have been provided for your exclusive use. This document is not intended for distribution to, or use by, any person or entity in any jurisdiction or country where such distribution would be unlawful under the securities laws of such. Any distribution, by whatever means, of this document and related material to persons other than those referred to above is strictly prohibited. For investors in Israel: BlackRock Investment Management (UK) Limited is not licensed under Israel's Regulation of Investment Advice, Investment Marketing and Portfolio Management Law, 5755-1995 (the “Advice Law”), nor does it carry insurance thereunder. In Singapore, this is issued by BlackRock (Singapore) Limited (Co. registration no. 200010143N). In Hong Kong, this material is issued by BlackRock Asset Management North Asia Limited and has not been reviewed by the Securities and Futures Commission of Hong Kong. In South Korea, this material is for distribution to the Qualified Professional Investors (as defined in the Financial Investment Services and Capital Market Act and its sub-regulations). In Taiwan, Independently operated by BlackRock Investment Management (Taiwan) Limited. Address: 28F., No. 100, Songren Rd., Xinyi Dist., Taipei City 110, Taiwan. Tel: (02)23261600. In Japan, this is issued by BlackRock Japan. Co., Ltd. (Financial Instruments Business Operator: The Kanto Regional Financial Bureau. License No375, Association Memberships: Japan Investment Advisers Association, the Investment Trusts Association, Japan, Japan Securities Dealers Association, Type II Financial Instruments Firms Association.) For Professional Investors only (Professional Investor is defined in Financial Instruments and Exchange Act). In Australia, issued by BlackRock Investment Management (Australia) Limited ABN 13 006 165 975 AFSL 230 523 (BIMAL). The material provides general information only and does not take into account your individual objectives, financial situation, needs or circumstances. In China, this material may not be distributed to individuals resident in the People's Republic of China ('PRC', for such purposes, excluding Hong Kong, Macau and Taiwan) or entities registered in the PRC unless such parties have received all the required PRC government approvals to participate in any investment or receive any investment advisory or investment management services. For Other APAC Countries, this material is issued for Institutional Investors only (or professional/sophisticated /qualified investors, as such term may apply in local jurisdictions) and does not constitute investment advice or an offer or solicitation to purchase or sell in any securities, BlackRock funds or any investment strategy nor shall any securities be offered or sold to any person in any jurisdiction in which an offer, solicitation, purchase or sale would be unlawful under the securities laws of such jurisdiction. In Latin America, for institutional investors and financial intermediaries only (not for public distribution). This material is for educational purposes only and does not constitute investment advice or an offer or solicitation to sell or a solicitation of an offer to buy any shares of any fund or security. If any funds are mentioned or inferred in this material, such funds may not been registered with the securities regulators of any Latin American country and thus, may not be publicly offered in any such countries. The provision of investment management and investment advisory services is a regulated activity in Mexico thus is subject to strict rules. No securities regulator within Latin America has confirmed the accuracy of any information contained herein.

The information provided here is neither tax nor legal advice. Investors should speak to their tax professional for specific information regarding their tax situation. Investment involves risk including possible loss of principal. 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.

Not FDIC Insured | May Lose Value | No Bank Guarantee

© 2019 BlackRock, Inc. All Rights Reserved. BLACKROCK is a registered trademark of BlackRock, Inc. or its subsidiaries in the United States and elsewhere. All other trademarks are those of their respective owners.