Carry is king

May 15, 2019

We see income, or carry, reasserting itself as the key driver of bond market returns, taking back the reins from price appreciation. The Federal Reserve’s strong reiteration of patience at its May policy meeting has reinforced our view that carry is king. A dovish tilt by other central banks and a slowing, but still growing global economy support this view.


Sources of income
Yields across various fixed income markets, 2015-2019

Yields across various fixed income markets, 2015-2019


Past performance is not a reliable indicator of current or future results. It is not possible to invest directly in an index.
Sources: BlackRock Investment Institute, with data from Thomson Reuters, May 2019. Notes: The lines show the yield of the following bond indexes at various points in time. Indexes used are the Bloomberg Barclays Global Aggregate Index, Bloomberg Barclays U.S. Aggregate Index, Bloomberg Barclays U.S. Corporate High Yield Index and the Bloomberg Barclays Emerging Market (EM) USD Aggregate Index. Indexes are unmanaged and not subject to fees.

  • Themes: A patient Fed – and a dovish tilt to monetary policy globally – should give comfort to investors in search of income. This is reflected in our upgrade (for fixed income only portfolios) of several credit sectors. See the Views tab. Yields are higher across global bond markets versus two years ago, offering greater income potential. See the chart above. Overall, we see a narrow path ahead for risk assets to move higher – but there are risks that could knock markets off track. U.S. Treasuries have historically played a key role in cushioning portfolios against such bouts of volatility.
  • Central banks: The big debate for the next couple of quarters: whether the Fed is pausing rate hikes or if rates have already peaked. Our take: Rates are on hold for the time being. The Fed may also allow inflation to run hotter, as it considers a change (unlikely for now, in our view) to its inflation targeting framework. We expect the European Central Bank to pause further steps toward policy normalization for 2019 and beyond, as it seeks to ensure a return of inflation. We believe the Bank of Japan may tweak policy earlier than markets expect, in an effort to improve the sustainability of its “yield curve control” policy.
  • Growth and inflation: Our BlackRock GPS indicates that the global expansion should continue through the year, albeit with global growth moderating further. We see U.S. growth slowing as the economic cycle moves into the late stage. We expect European growth to find firmer footing later this year (read our recent Macro and market perspectives), but worry about the ECB’s lack of policy levers to counter any future downturn. We are increasingly confident the Chinese economy will turnaround in the second quarter, fueled by fiscal and monetary policy easing. Global inflationary pressures remain subdued, particularly in the eurozone and Japan.
  • Risks: We believe the U.S. economy can remain in the late-cycle phase, avoiding recession throughout 2019. We see little sign of economic overheating or inflationary pressures. A resurgence of recession fears or inflation pressures that force the Fed to resume tightening pose risks to our outlook, as detailed in our Q2 2019 Global investment outlook. Other risks include an intensification of U.S.-China trade disputes or a U.S.-Europe trade showdown. Read more about key risks on our BlackRock geopolitical risk dashboard.

Fixed income views

Our views are from a U.S. dollar perspective over a three-month horizon. Views and comments are from a fixed income-only perspective, and may differ from whole-portfolio tactical views on fixed income in our Global weekly commentary. For example, we overweight U.S. credit and emerging market debt from a fixed income perspective because of their income potential. Yet we are neutral on these asset classes in a multi-asset context, where we prefer to take economic risk in equities. Views are as of May 1.


Rates View Comments
U.S. government bonds icon-neutral We are cautious on U.S. Treasury valuations after the recent rally, but still see the bonds as important portfolio diversifiers given the traditional inverse relationship between U.S. equity and government bond returns. We see recent moves as excessive and advocate patience before increasing exposure. We prefer shorter dated bonds and expect a gradual steepening of the yield curve, driven by still-solid U.S. growth and the Fed’s stated willingness to tolerate inflation overshoots.
U.S. inflation protected icon-up We prefer allocations to inflation-protected securities amid a slowing but growing economy, the likelihood of a steeper yield curve and potential for higher market-based inflation expectations. The Fed has confirmed its intent to be patient with its next rate move and may let inflation temporarily breach its 2% target. We see inflation-protected securities as an attractive alternative to nominal bonds.
U.S. agency mortgages icon-down We are underweight the asset class in the near term, following recent outperformance by current-coupon mortgages against other asset classes — especially in risk-adjusted terms. We do see opportunities in high-coupon mortgages or specified pools.
U.S. municipal bonds icon-up We expect coupon-like returns amid favorable supply-demand dynamics and a benign interest rate backdrop. New issuance is lagging the amount of debt that is called, refunded or matures. The tax overhaul has made munis’ tax-exempt status more attractive in many U.S. states, driving inflows. Munis also generally display less sensitivity to rate moves.
Global rates ex U.S. icon-neutral We have upgraded our view to neutral from underweight. European sovereign bonds offer an attractive income opportunity for U.S.-dollar based investors on a currency-hedged basis. In the near term, we expect the European Central Bank will remain accommodative and further dampen volatility in the European bond markets. Any further deterioration in U.S.-European trade tensions could push European sovereign yields lower.


Credit and other View Comments
U.S. investment grade icon-up We see three themes for this asset class in 2019: more attractive valuations, opportunities in BBB bonds and the importance of security selection given recent volatility. We prefer an up-in-quality stance overall, but recent spread widening has cheapened valuations and may also offer an attractive opportunity in BBB-rated credits. Increased demand for income amid stable monetary policy, signs of more conservative corporate behavior and constrained supply remain supportive for the asset class.
U.S. high yield icon-up We like the asset class for its income potential. We see generally healthy corporate fundamentals, supportive supply-demand, and the rally in credit markets during the first quarter places current valuations near our estimate for fair value. Weaker earnings growth in 2019 relative to consensus estimates may inject volatility into credit markets, but we view this as an opportunity to add value through credit selection.
U.S. bank loans icon-neutral We have upgraded our view to neutral from underweight. We view bank loans as an attractive source of high-quality income, and their floating-rate nature can potentially provide a cushion against rising rates. Demand for bank loans may be challenged in the near term, but lower loan supply is an offset. We prefer balanced exposures across the quality spectrum and advocate a selective approach in market pockets where deteriorating credit quality is concentrated — such as in “loan only” and smaller capital structures.
U.S. securitized assets icon-up We like securitized assets for their relatively attractive yields and income potential, as well as their stability and diversified credit exposure. We favour a diversified approach that balances allocation to residential and commercial mortgage backed securities (RMBS and CMBS), collateralized loan obligations (CLOs) and whole loans, as well as asset-backed securities (ABS).
Euro investment grade icon-neutral We have upgraded our view to neutral from underweight. “Low for longer” ECB policy as well as recent weak economic news should reduce market volatility and support the asset class. European bank fundamentals now appear in decent shape with sufficient capital levels, after years of de-risking and repairing balance sheets. We see attractive relative value and income potential in BBB bonds over the near term.
Euro high yield icon-up We have upgraded our view to overweight from neutral. We see European high yield supported by muted issuance and strong inflows. Valuations have risen a decent amount since the beginning of the year, yet still look attractive amid slowing economic growth and limited default risk. Euro high yield also offers a significant spread premium to U.S. counterparts. For global investors, we see the additional yield offered from a currency-hedged exposure back to U.S. dollars as attractive.
Emerging market debt icon-up Prospects for a turnaround in Chinese growth and a pause in U.S. dollar strength support both local- and hard-currency markets. Valuations appear attractive to us despite the recent rally, with limited new issuance adding to the positives. Risks include further deterioration in U.S.-China relations and slower global growth.
Asia fixed income icon-up We favor investment grade in India, China and parts of the Middle East, and high yield in Indonesia. Portfolio rebalancing could cause material capital inflows into China from other countries, as China’s opens its markets to foreign capital and Chinese assets get included in international bond and equity indices. We are cautious on Chinese government debt despite its inclusion in global indexes from April.

icon-up Overweight     icon-neutral Neutral     icon-down Underweight

Scott Thiel
Chief Fixed Income Strategist, BlackRock Investment Institute
Scott Thiel, Managing Director, is BlackRock's Chief Fixed Income Strategist with responsibilities in developing BlackRock's strategic and tactical views.