Strategic Income Opportunities Fund Monthly Insight

What bond investors should be watching

May 24, 2018

Fed action is important, but it’s not the whole story.

Markets and the media have been highly focused on the Federal Reserve’s tone around rate hikes. But whether the Fed raises rates three or four times this year actually won’t make that much of a difference. We believe the Fed is likely to stay on its expected path, and even if inflation were to pick up, a faster pace of rate hikes wouldn’t break this economy.

In our opinion, there are other things investors should be watching more intently: the trade dynamic, for one. The outcome of negotiations between the United States and China could have a significant impact on global growth, particularly when you consider that China is the engine churning out nearly half the world’s economic growth.

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

Additionally, we think the market is underestimating the size of the U.S. fiscal stimulus package. Together, tax reform and spending plans have the potential to create strong growth for the next few years, whether it’s through increasing capital expenditure, the repatriation dynamic, lower personal income tax or the sheer size of the fiscal spend on infrastructure projects.

This level of stimulus injected into an economy that is already growing well, not only allows the Fed to stay on its path, but could push the already low unemployment rate (near 4%) as low as 3% – a point where you can count on higher inflation and more rate volatility. Therefore, investors need to be careful about where they take risks and be flexible and tactical with their interest rate exposure.

Outperformance with lower volatility

Outperformance with lower volatility

Source: Morningstar as of 4/30/18. Returns are from 4/30/17 through 4/30/18. Volatility is measured from 4/30/17 through 4/30/18 using daily returns. For standardized performance of the BlackRock Strategic Income Opportunities Fund, click here.

In the Strategic Income Opportunities Fund, we hold duration mainly in the 0- to 2-year part of the yield curve, but we added to the 7- to 10-year space as we believe rates have met the highs of their near-term range. We hold inflation protection positions (in breakeven form) on the front end and the 3- to 5-year part of the curve as we believe the market is underestimating future inflation rates. We have continued to reduce the fund’s credit exposures in favor of mortgages and securitized assets, which we believe should continue to experience strong demand as we are still in a low yield environment relative to historical norms.

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