How investors and traders look at the world through different lenses

Jun 16, 2017

In our monthly fixed income market outlook, Rick Rieder, BlackRock’s Chief Investment Officer of Global Fixed Income, discusses how market participants today appear to display remarkable conformity in views, and consequently in positioning. Thus, we think it’s vital to genuinely understand the type of investor you are, your time horizon, goals, and the conditions within which you must operate, to help determine investment timing and maximize return potential. The foundation for investment still needs to be a strong focus on the secular drivers of economic change (aging demographic trends and disruptive technology), as these forces are reordering cash flow dynamics around the world. Finally, while the secular level of analysis is vital, investors would be remiss to ignore the continuities and changes within medium-term cyclical dynamic and also should make a regular practice of filtering out short-term market noise.

Market outlook summary:

  • Longtime readers of the market outlook will know well that we have been keenly interested in examining how both demographic trends and technological innovation can influence the economy and markets over time. Indeed, this has been such an emphasis because we think these are some of the most critical factors toward determining investment success and failure over the next couple of decades. That said, it’s also important to note that these changes (while longstanding) are profoundly impacting market pricing and prospects right in front of us, virtually every single day. These are not issues to be relegated to the “interesting, but for later” catalogue of concerns, they’re playing out now.
  • The aging profile of many developed market counties’ populations (as well as those of some emerging market countries) continues to be one of the most significant forces driving secular demand for yielding assets, and it comes at a time (partly due to the central bank response to the global financial crisis) when both absolute yield levels are very low and the availability of net supply is meager. Of course, central banks are attempting to utilize extreme policy measures to in part counteract a largely demographically driven “lower growth potential” in their respective economies, but ultimately are exacerbating the lack of income availability, which results in a tremendous fixed income supply/demand imbalance that deserves scrutiny.
  • Therefore, perhaps it’s not that surprising that even with the prospect of moderately rising interest rates in the U.S. and elsewhere, inflows into fixed income funds continue to press yields and spreads to very aggressive levels. On the monetary policy front, the European Central Bank and the Bank of Japan have effectively purchased all the net issuance of their governments since before the financial crisis, leading available fixed income supply to be overwhelmed by demand (see Figure 1 in the market outlook). This dynamic could begin to change over the next year, as the Federal Reserve eventually allows its balance sheet to runoff and the ECB starts to taper QE asset purchases.

2017 European, EMU-11, Net Fixed Income Supply (Billions of €)
(Net of ECB QE Purchases)

2017 European, EMU-11, Net Fixed Income Supply

Source: European Central Bank, data as of March 31, 2017
Note: The EMU is the Economic and Monetary Union and EMU-11 refers to the 11 initial European countries in the EMU.

  • There is an abundant amount of market commentary today that makes the case that the recovery period after the 2008 global financial crisis and recession is now quite long in the tooth, and that therefore we currently reside at a late-cycle stage of the expansion. If time itself were the key determinant that characterizes the economic cycle, then this view might have merit, but in our view economic cycles are more adequately defined by the state of the economy, and not merely by time. As a result, BlackRock Investment Institute economists have developed a fascinating conceptual framework with which we can more properly judge our stage in the economic cycle. As a result of our analysis of these data series, we believe that we’re likely to see the current economic recovery last at least another year or two, and not merely the couple more quarters that many commentators have contended.
  • We briefly examined the secular drivers of market change, we explored our views on where we believe the economy to be located within the medium-term business cycle, and finally we share some thoughts on the difficult task of separating short-term news from noise. Indeed, one risk investors face is overestimating the impact of shorter-term political risk events on market movements. Over the past year, most market participants have taken risk down to such an extent leading up to political risk events that markets have (perhaps unexpectedly) spiked higher post event, regardless of outcome.
  • Therefore, for at least the balance of the year, if not considerably longer, we think that investor focus should be on following the cash-flow changes around the world across the major secular and medium-term trends we have identified, and not excessively on purported political event risk. We believe doing that helps mitigate the risk that investors over-focus on shorter-term political dynamics that ultimately have less relevance for markets. Of course, investors need to keep an eye on the possibility that political risks become more concerning, but they should primarily follow the cash flow dynamics that longer- and medium-term forces are radically reshaping.
Rick Rieder
Managing Director, Chief Investment Officer of Global Fixed Income
Rick is BlackRock's Chief Investment Officer of Global Fixed Income. He is a member of BlackRock's Fixed Income Executive Committee, a member of its Leadership ...