BlackRock's Rieder on bonds, rates, the Fed in 2015
RICK RIEDER
CHIEF INVESTMENT OFFICER OF FUNDAMENTAL FIXED INCOME, BLACKROCK
2015 BOND MARKET OUTLOOK:
The Federal Reserve will start hiking short-term interest rates in 2015, but the early stages of the transition to higher borrowing costs won't lead to massive turbulence in the bond market or cause yields on longer-term bonds to skyrocket as many on Wall Street fear, predicts Rick Rieder, chief investment officer of fundamental fixed income at BlackRock.
One of the big market stories in 2015 will be the start of the Fed's move to normalize historically low rates. The Fed ended its market-friendly bond-buying program in October. As the job market heals and the unemployment rate, at 5.8%, is likely to sink further, the Fed is likely to start raising rates next year for the first time since 2006. Rieder, who oversees $680 billion in assets, predicts the Fed will boost rates, currently pegged at 0% to 0.25%, to 1%.
Unlike many doomsayers, Rieder struck a far-less ominous tone on how markets would react to a less accommodative Fed. Considering that demand for bonds is still greater than supply because of aging demographics, sub-par global growth and the fact that central banks in Europe and Japan are injecting more stimulus into the global financial system, Rieder sees less chance of long-term rates skyrocketing.
"I think the concept, that when the Fed starts moving (rates higher) that it is going to be a problem for markets, is dramatically overblown," says Rieder, who manages three BlackRock bond funds, including its Total Return Fund, its Strategic Income Opportunities Fund and Core Bond Fund. "We think that we will be in a low rate dynamic for a very long time."
He says fair value on the 10-year Treasury, which closed Thursday a tad below 2.2%, is about 2.75% to 2.8%. He says it could get that high next year.
BIGGEST RISK:
While Eurozone and Japanese central bankers stimulate their economies with easy-money policies, there's a risk that monetary policy alone won't work and demand won't pick up, he warns. The right fiscal policies also must be implemented. "If the markets get a sense that monetary policy is not working, and it is just buying time and (there are) no fiscal initiatives or no real growth, then all of the markets will start to turn down," he says.
TOP BOND PICKS
Long-dated municipals. 10- and 30-year bonds issued by states and local governments to fund projects, such as roads and schools, are a good bet if long-term rates stay well-behaved and yields don't spike sharply, as Rieder expects. Depending on the state you live in, investors can get a 7% to 8% tax equivalent yield.
Commercial mortgages. This pocket of the fixed-income market is not a "crowded trade." It's a less-populated part of the bond market. As a result, it offers good opportunity. Leverage in real estate has come down sharply, less debt is being created and supply of commercial mortgages is limited. The upside: You can pick up nice yields on commercial properties with not a lot of debt attached.
India 10-year government bonds. There are fixed-income opportunities abroad, in places such as India, where consumer inflation, which clocked in at 5.5% in October, will come down over time, and long-term government bonds yield almost 8%. Like the European Central Bank, India's new leadership has taken steps to stimulate its economy, but its plump bond yield is more attractive than, say, Italy's 2% rate on its 10-year bond.
Mexico 10-year government bonds. Global bond diversification makes sense in 2015. You can get better yields on Mexican sovereign paper than you can on U.S. long-term debt.
Europe subordinated bank debt. This type of debt is considered more risky, since the holder of the debt won't get his principal repaid if the lender defaults until more senior debt holders are paid. But Rieder says the risk is worth taking as Europe has moved to recapitalize its banking system and reduce leverage in the system. It's a good yield play, given the ECB's aggressive easing policy.
Disclosures: Opinions presented are Rieder's and may change. The information is not intended to be relied on as a recommendation or solicitation to buy or sell.
FAVORITE SECTOR:
Municipal bonds. Long-term bonds issued by towns, cities and states are one pocket of the bond market that could deliver yield-starved investors with returns of 7% to 8%, assuming long-term U.S. Treasuries don't shoot sharply higher, as Rieder predicts.
INVESTMENT THEMES WORTH BETTING ON:
• Diversify. Don't follow the investing herd, he warns. Too many investors are crowding into the same trades. "Everybody is long the dollar, everybody is short U.S. interest rates, and long European front-end interest rates," he says. To avoid getting hurt in those trades in the event they reverse and the tide quickly moves in the other direction, Rieder says, "you have to diversify like crazy."
• Go global. The Fed is set to start hiking rates for the first time in more than eight years, so seeking stable and sizable yield abroad makes good sense, from both an income and diversification standpoint. "Investors have to think about where in the world rates are going to stay stable or potentially decline," he advises.
