German elections and tapering – What should investors do? – BlackRock’s Rosenberg responds

Jeffrey Rosenberg, BlackRock’s Chief Investment Strategist for Fixed Income, discusses rising bond rates, tapering and the German Federal elections.

Bonds go up when stocks go down, right? Not anymore. With YTD returns through September 6th of -3.65% for core fixed income, avoiding an annual loss will require a major shift lower in interest rates, something we do not expect. An annual negative return in 2013 would represent only the third loss over the last 33 years. More importantly, that loss highlights the rapidly changing dynamics for investing in fixed income.

Despite a disappointing employment report for August, we expect the Fed to announce a modest program of tapering at the conclusion of its September 17-18 FOMC meeting. Increases in rates towards 3% reflect this as well as a Larry Summers nomination, leaving rates vulnerable to decline if either data or the nominee surprises. Nevertheless, recent stronger economic reports undermine our prior year target for the 10-year of 2.5%, and we upgrade that forecast to 2.5%-2.75% for year end.

German Federal elections September 22nd cap the surprising bright spot in the global picture of an improving European economic outlook. Adding to the global reasons for rising interest rates in the US, Chinese economic data stabilization removes some downside risks to global growth. Syria and Emerging Market currency crises highlight global risks scenarios that could lead to falling rates.

Rising rates reflect both stronger global economic growth and shifting expectations for both tapering and the next Fed chairman. Significant risks remain and 10-year rates approaching 3% begin to look attractive. The potential to overshoot remains so we’ll continue to underweight rate-sensitive segments of fixed income (Treasuries, mortgages and TIPS). Rising rates in August led to underperformance of high yield bonds vs. bank loans. The potential for this to continue in the short run leads us to putting high yield at “neutral” and bank loans to “overweight.” Emerging markets continue to be under stress with currency uncertainty in India and Indonesia alongside fears of further global outflows attendant with Fed tapering; we remain neutral regarding an outright recommendation in EM debt. In municipals, higher rates and a steeper curve has restored some value to the broader municipal market with yields their highest since early 2011. However, Puerto Rico bonds finally began to reflect the long deterioration in fundamentals and our longstanding concerns.

BlackRock oversees $1.2T in fixed income assets including $632B in actively managed fixed income assets for clients.

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