FIXED INCOME STRATEGY

A mighty (tail)wind

Apr 9, 2018
By Jeffrey Rosenberg, Matthew Kraeger, Thomas Kolimago

Tax cuts and plans for more government spending are adding fuel to already solid U.S. growth prospects. One result: The market has now caught up with the median interest rate path projected by the Federal Reserve policymakers. We focus on rising opportunities at the front end of the curve.

Fixed income highlights

  • We see short-term U.S. debt offering relatively compelling income, with limited downside risk: Three Fed rate hikes are already priced in for this year, with the first likely this month. Markets could price in one additional quarterly hike after that Fed meeting (making a total of four for 2018), but we see a more rapid pace as unlikely.
  • Technical factors such as increasing U.S. Treasury bill issuance – the result of a surging budget deficit – are adding to the factors pulling short-term yields higher. As a result, short-term Treasuries offer positive real yields for the first time since the financial crisis, with income sufficient to offset inflation.
  • Higher yields favor short over long maturities in government debt. We like floating rate and inflation-linked securities as buffers against rising rates and inflation, and also see opportunities in 15-year mortgages. We prefer an up-in-quality stance in credit, favoring investment grade over high yield.

Snapshot

Market participants have finally come to terms with the Fed’s normalization plans. Their expectation for short-term interest rates has risen to catch up with the Fed’s median forecast in its Statement of Economic Projections – after having lagged behind it for most of the post-crisis period. See the Playing catchup chart.

Market vs. Fed outlook for Fed funds rate, 2015-2018
Jeffrey Rosenberg
Chief Fixed Income Strategist
Jeffrey Rosenberg, Managing Director, is BlackRock's Chief Fixed Income Strategist with responsibilities in developing BlackRock's strategic and tactical views.
Thomas Kolimago
Global Head of Credit and Investment Research, BlackRock Trading and Liquidity Strategies
Thomas Kolimago, CFA, Managing Director, is a member of the Cash Management team within BlackRock's Trading and Liquidity Strategies Group. He is Global Head of
Matthew Kraeger
Lead Portfolio Manager, Mortgage Portfolios
Matthew Kraeger, Managing Director, is lead portfolio manager for mortgage portfolios within BlackRock's Americas Fixed Income Alpha Strategies. He is ...