For qualified investors

Reflation

Summary

We see reflation taking root and believe global bond yields have bottomed. We prefer equities over fixed income, credit over government bonds, short- over long-duration bonds and value over bond-like equities.

What’s changing?

Improving growth and the prospect of fiscal expansion in the US and elsewhere are fueling higher inflation expectations. Interest rates globally are liable to recalibrate to reflect this “reflationary” dynamic in 2017, pushing yields upward, causing pain for holders of long-duration bonds. Steepening yield curves (see below) suggest investors should consider pivoting toward shorter-maturity bonds within their fixed income portfolios, preserving liquidity and otherwise preparing for increased bond market volatility.

Steeper and steeper

Government bond yield curves in selected countries, 2000–2016

Government bond yield curves in selected countries, 2000–2016

Sources: BlackRock Investment Institute and Thomson Reuters, November 2016.
Notes: The lines show the difference between benchmark 30- and two-year government bond yields for each country in percentage points.

Equity markets are also in flux. Rising global inflation is contributing to a big sector rotation in equities, one we believe likely to persist. Laggards such as financials have recently soared and, while winners could face short-term pullbacks, low-volatility shares that shone in the first half of 2016, e.g. utilities and telecoms, may continue to suffer if rising bond yields gather steam. In this environment, dividend growers – companies with sustainable free cash flow and the ability to raise payouts over time without harming their balance sheets – look attractive.

Download our report on reflation

Suggestions for a reflationary environment: Be selective for growth

Funds that could help: