Strategic Income Opportunities Fund Monthly Insight

Focused on inflation? Look at the big picture

Jul 18, 2017

Markets have been sensitive to inflation reports, but could this obsession with short-term data be overly zealous? The industry leader in fixed income management* considers the big-picture trends transforming the inflation landscape.

Market behavior of late has been reflecting a micro-focus on short-term inflation data and speculation around the Federal Reserve’s next move. However, we believe the central bank’s employment and inflation mandates are effectively accomplished at this stage, when viewed in the proper forward-looking context. Monetary policy is intended to be a tool for promoting the health of the U.S. economy. As such, policy decisions are prudently influenced by long-term trends as opposed to short-term transitory, seasonally weak data.

When thinking about inflation, we look at the big picture, which is painted by long-term trends. We see technological innovation and an aging population as the key forces remaking the inflation landscape. Historically, technological innovation has proved to be deflationary, exerting downward pressure on prices. As the pace of technology development continues to accelerate over time, we increasingly see the disruption of traditional business models in many industries, putting a lid on prices as goods and services are produced with greater efficiency. Meanwhile, the world’s aging population is likely to keep growth – and inflation – lower than in the past as older participants generally draw more from the economy than they contribute.

While looking at trends through a big-picture lens provides a more sensible view of growth and policy decisions, it is also important for investors to remember that global financial conditions are still highly accommodative and that the Fed is normalizing rates from excessively low levels. We believe the Fed’s June rate hike made sense as the U.S. economy is ready for this policy transition. The Fed acknowledged the recent softness in top-line and core inflation and promised to keep a keen eye on adjusting its course if U.S. inflation disappoints further.

In the BlackRock Strategic Income Opportunities Fund, we increased portfolio duration from 1.6 to 2.0 years during the month of June. This reflects our views that 1) inflation levels have probably already peaked in this cycle, 2) economic momentum is slowing in the near term, and 3) the market has priced out the possibility of strong fiscal policy. That said, we do believe interest rates could edge slightly higher in the near term. We expect to see one more rate hike from the Fed as well as some reduction of the U.S. balance sheet later this year.

Over the past year, we’ve experienced periods of declining, rising and flat interest rates, as well as periods of high and low volatility, but BlackRock Strategic Income Opportunities Fund provided consistent positive performance with low volatility. The chart below illustrates the outperformance that can be achieved through flexibility and diversification.

Outperformance with low volatility in a changing rate environment

Chart: Strategic Income Opportunities Fund

Source: Morningstar as of 6/30/17. Returns are from 6/30/16 through 6/30/17. Volatility is measured from 6/30/16 through 6/30/17 using daily returns. For standardized performance of the BlackRock Strategic Income Opportunities Fund, click here.

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