FIXED INCOME MONTHLY

Lather. Rinse. Repeat.

May 13, 2016 / By Jeffrey Rosenberg

Jeff Rosenberg discusses China's economic policy and
why it matters to fixed income investors.


Highlights

  • Trees cannot grow to the sky.  This most memorable quote from an “authoritative insider’s” editorial outlined what most analysts view as a direct communication of China macro policy intent from President Xi Jinping. Xi appears to directly criticize the recent stimulus policies of China, policies we outline below that stand behind much of the recovery in financial markets since mid-February. If so, this communication holds great importance to the macro outlook questioning the durability of the rally.
  • Lather. Rinse. Repeat. China’s pattern of ramping up credit growth in response to a macro economic slowdown is now well familiar. So, too, are the unintended consequences of stoking asset price bubbles, with the latest showing up in Chinese commodity markets. And while financial market concerns appear to have dissipated and commodity and commodity-related credit prices have recovered significantly their recent losses, the fundamental and longer lasting efficacy of such policies underlying the recovery appears increasingly suspect. Consider only the latest crackdown on financial and economic reporting and analysis likely would not be happening if the success of these policies were manifest. The risk that market fear fills the vacuum of knowledge created by the crackdown remains a major downside scenario.
  • Why a renminbi devaluation—and the value of the dollar—matters. It’s because the world’s debt is denominated in dollars. And as the dollar gets more expensive, or equivalently as the renminbi cheapens, that debt becomes harder to service. Fears of a massive one-off China devaluation gripped markets in mid–February and the PBOC helped to quell such concerns. For a deval in China wouldn’t stay in China; it would likely force most other emerging markets to devalue. And given that in this cycle that is where the credit vulnerabilities most greatly lie, default expectations go up when those local currency values drop versus the dollar. No wonder, then, that the Federal Reserve now finds itself hard pressed to normalize interest rates anywhere near the four times indicated at the end of last year. Looking forward, it might not even get one.

Strategy and outlook

With a significant recovery in credit markets now behind us, to get to even higher levels requires a return to prices seen last May. That means unwinding the entire risk premium in place in the aftermath of the collapse in expectations for the commodity rebound, as well as the risk premium from China growth and stability fears. While such compression may continue, we anticipate in the best case income with no price appreciation going forward. With limited upside and still considerable downside risks, the pursuit of income tempered by downside risks keeps our outlooks across most risky fixed income assets at neutral this month. We also take down our view on Treasurys this month to underweight, with focus on the front end, where pricing out of Fed tightening may have gone too far. We still express a relative preference for longer-duration exposure.

Jeffrey Rosenberg
Managing Director, Chief Investment Strategist for Fixed Income
Jeffrey Rosenberg, Managing Director, is BlackRock's Chief Investment Strategist for Fixed Income which is responsible to develop BlackRock's strategic and tactical views on sector allocation within fixed income, currencies and commodities.
Jeffrey Rosenberg
Managing Director, Chief Investment Strategist for Fixed Income
Jeffrey Rosenberg, Managing Director, is BlackRock's Chief Investment Strategist for Fixed Income which is responsible to develop BlackRock's strategic and tactical views on sector allocation within fixed income, currencies and commodities.

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.

The fund may use derivatives to hedge its investments or to seek to enhance returns. Derivatives entail risks relating to liquidity, leverage and credit that may reduce returns and increase volatility.

The opinions expressed are those of BlackRock as of May 10, 2016, 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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