21 September 2015

When it does eventually come, there can be little doubt that the first US rate rise since the global financial crisis will be interpreted by the markets as a significant event. For now, the Fed has held-off tightening policy in the face of inflation well below its target rate, increased market volatility, concerns about global growth and many central banks around the world moving in the other direction.

The hunt goes on

However, a 25 basis points increase in the federal funds rate won’t change one of the key investment themes of the last decade: the hunt for income. Yes, there will be some re-pricing of assets, but given the intense focus there’s been on the Fed over the last year, it’s reasonable to assume that this is an event that is broadly priced in.

Believe the bond markets

In bond markets specifically, it’s important to remember that the Fed only really has influence over the front end of the yield curve; the back end is driven more by the demand for longer-dated assets from institutional investors coupled with inflation expectations. And it’s the bond market’s expectations of where long-term yields will be in a decade’s time that’s truly shocking: 10-year forwards currently indicate bond investors believe that the yield on US 10-year Treasuries will be just 3.1% in 2025. At the time of writing, the yield on US 10-year Treasuries is 2.2%, according to Bloomberg data. While this might be something of an overreaction to the ‘low for longer’ narrative, it’s hard to envisage a scenario where government bond yields are going to move significantly higher over the next few years.

Meanwhile, in Europe and Japan…

What’s more, we should remember that other major economies are in full-on easing mode. The European Central Bank’s (ECB’s) sizeable quantitative easing (QE) programme kicked off this year and Mario Draghi is already making noises about increasing the scope. A slump in Japan GDP has triggered speculation that the Bank of Japan will be forced to launch a further round of QE this autumn, adding to its already-mammoth programme. Yields on European and Japanese bonds are going to stay low for the foreseeable future, so it’s likely investors in these regions might look overseas for yield, namely the US and the UK, pushing prices up and yields down on Treasuries and Gilts that are already under pressure from low inflation expectations.

Looking for returns in all the wrong places?

Global growth – while still broadly positive – has slowed and I therefore don’t expect to see significant upside in equity markets over the near-term. While closer to fair value following the recent pull back, stock markets have been on a well-documented bull run for some years; even if the Fed does boost risk appetite by raising rates before the end of 2016, how much higher can equities go from here? I do believe equities might generate moderate returns – perhaps mid-to-high single digits – over the next few years, but not much more than that.

In a world where equity returns are likely to be lower than they have been over the last few years, how might investors generate reasonable returns from their investments without having to accept significantly higher risk? Well, I believe that actually taking the coupons from bonds and the dividend payments from dividend-paying equities is a strategy some investors might want to consider.

For the more sophisticated investor, taking the income that comes with writing options could provide a similar source of additional return – but selling options can be a complex and time-consuming exercise. That’s partly why these types of strategies are a critical component of the BlackRock Global Multi-Asset Income Fund – we want to give investors a straightforward way to take a consistent level of income from their investments without having to become options traders.

CARS ref: RSM-1981
This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or financial product or to adopt any investment strategy. The opinions expressed are as of 18 September 2015 and may change as subsequent conditions vary.

At the time of writing, the yield on US 10-year Treasuries is just 2.2%.