Strategic Income Opportunities Fund Monthly Insight

What’s next for the economy and interest rates?

Jul 30, 2018

The Strategic Income Opportunities portfolio management
team shares its views for the near-term and beyond.

Labor markets continue to power ahead, highlighting the underlying strength of the economy, despite some added uncertainties and headline risks, notably global trade tensions. On the inflation front, June’s headline core price index came in slightly below expectations, but general price levels are still firming and this softer data is not likely to alter the Federal Reserve’s narrative around moving interest rates higher in 2018.

As it’s widely expected that the Fed will maintain its well-telegraphed path this year, the main question becomes: what is the next phase for the economy? We think that at some point over the next year or so, eventual higher wages, and other higher input costs for companies (particularly if accompanied by sustained tariffs), as well as a pull-forward of capital expenditures by companies, may lead to an economic slowdown from the second quarter’s buoyant pace. For now, though, the U.S. economy is operating quite nicely and should continue to be solid for the near term.

With today’s growth in the bond markets, you need to be mindful of interest rate risk.

– Rick Rieder, CIO and Co-Head of Global Fixed Income

While the Fed’s rate hiking has brought attractive value to the front end of the yield curve, we anticipate that longer-term rates could also move moderately higher this year. For context, the 10-year Treasury rate was range-bound between 2.1% and 2.6% throughout 2017, but since January of this year, the trading range has stair-stepped higher to roughly 2.7% to 3.1%; recently near 2.84%. Higher levels of Treasury issuance to fund fiscal stimulus measures, more than concerns over inflation, are likely to press rates higher toward the top end of that range in the months to come, but we do not anticipate an increase in rate levels that would be overly concerning. That’s particularly the case if markets should price in expectations for an economic slowing next year.

Outperformance with lower volatility

Outperformance with lower volatility chart

Source: Morningstar as of 6/30/18. Returns are from 6/30/17 through 6/30/18. Volatility is measured from 6/30/17 through 6/30/18 using daily returns. For standardized performance of the BlackRock Strategic Income Opportunities Fund, click here.

In the Strategic Income Opportunities Fund, we hold the majority of duration in the 0- to 2-year part of the yield curve, but we also hold exposure in the 7- to 10-year space as we believe rates are hovering around the highs of their near-term range. We maintained the fund’s inflation protection positions (in breakeven form) on the front end of the curve given the firming of producer and consumer prices during the second quarter.

We slightly increased the fund’s allocation to investment grade credit on the front end of the curve and continue to hold high quality names for income generation. We continued to reduce the fund’s overall emerging market exposure as a stronger U.S. dollar and global trade tensions are creating a headwind for the sector. However, we continue to hold select positions in China, Argentina and Indonesia.

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