Jeff Rosenberg, BlackRock’s systemic multi-strategy fund portfolio manager, tells Piyasi Mitra how his team is navigating the current yield environment amid global inflation fluctuations.
How is BlackRock’s Systematic fixed income product strategy team navigating the current yield environment, particularly given the recent fluctuations in global inflation rates?
There has been a trade-off between yield levels and volatility. The reset in global yields higher following central bank tightening in the wake of post-covid inflation led to three major factors in a departure from pre-covid conditions. These include 1) higher starting yields, 2) inverted curves and 3) significantly higher rate volatility.
The transition period was one in which there was little carry cushion, heightened volatility, and generally upward movements in yields leading to a poor risk-reward prospect for long rate exposure. By mid-2023, the outlook had changed again considerably. Improvements in inflation, especially in the second half of the year, led to better outlooks for directional positioning. Additionally, extreme inversion in the US yield curve, coupled with aggressive signalling by the Federal Open Market Committee of future rate cuts, prompted steepening yield curves benefiting both levered and unlevered expressions in front-end curve positions.
Navigating volatility in inflation dynamics meant balancing valuations, technicals, and fundamentals. By the end of 2023, curve steepening positions became highly consensus and crowded, creating conditions for a reversal which a shift in the inflation data provided. That shift in inflation data also altered the directional perspective on rates. The latest surprise positive April US CPI report reversed some of these directional trends leading to a somewhat more constructive directional US rate position.
In what ways are you advising European fund managers to take a dynamic approach to asset allocation to adapt to the evolving market regime?
For European managers, dollar rate exposure played a stabilising and diversifying role following a few key characteristics of US rates in the global market. Flight to quality generally meant both lower rates and a stronger dollar. The Fed could be relied upon to reduce risk through the provisioning of liquidity and cutting rates. Additionally, the relatively strong fiscal position of the US (historically and relatively speaking), coupled with size and liquidity advantages, meant US rate exposures made excellent portfolio diversifiers (whether considering a hedged or unhedged perspective). Monetary policy in a world of above-target inflation implies the consideration of greater trade-offs.
We are now operating in a world where there is less presence of massive central bank balance sheet expansion which was present during the QE era. This means that long-end rates may not be as reliable a form of diversification exposure as they were pre-covid, as term and inflation term premiums are starting at historically low levels. Secondly, the combination of heightened inflation, fiscal, and policy uncertainty has led to an elevated level of rate volatility. One perspective is that this level has surged higher due to those factors. However, a longer perspective highlights a different interpretation. Rather than volatility being elevated, it was the prior period of low levels of volatility that was the aberration – high levels of volatility are more of a return to normal.
Could you elaborate on the strategies BlackRock employs to capture the potential decades-high yields within the bond market?
In BlackRock’s systematic fixed income, higher yields have restored the value of risk-free duration exposure relative to the current level of inflation uncertainty. The sharply inverted curve has made the short end of the yield curve most attractive. In credit, yields on corporate bonds also reflect the rate and curve dynamics. However, credit spreads reflect a benign default outlook, more limited interest rate sensitivity due to good liability management practices by borrowers, and inflation pass-through supporting margins and credit quality. As a result, while yields are attractive, spreads reflect more of an income rather than a capital appreciation opportunity. Nevertheless, the soft landing economic consensus outlook supports extending exposures into credit and a less defensive posture.
What indicators are you monitoring to identify signs of market change, and how do these inform BlackRock’s fixed income investment decisions?
We use several inputs or “signals” to help guide our strategic and tactical asset allocation models. Given the dominance of the inflation outlook, inflation market prices as well as commodity inputs to inflation and interest rate pricing are key inputs for duration positioning. For credit and risky assets, in addition to economic fundamental data like PMI new orders and labour market indicators, we use both standard government data and alternative labour wage data from internet job postings to help inform the outlook for growth and monetary policy. We also use web-scraped measures of inflation to augment more traditional measures of inflation and provide a faster read on inflation momentum. Additionally, we look into relative equity performance across sectors and custom baskets formulated to reflect different states of economic performance to help gauge real-time pricing of macroeconomic developments.
Considering the current economic landscape, how do you see bond allocation levels evolving, and what implications does this have for European fund managers’ investment strategies?
We see bond allocations evolving towards less use of traditional bond strategies. These strategies have two major components that are no longer as fit for purpose in a post-covid global market structure. First, those traditional strategies have long durations of six to seven years, and second, that duration exposure is primarily at longer maturity points on the curve. Those two characteristics were optimal in a world of falling interest rates and falling term and inflation premia, and maximised yield in a world where persistent errors in forecasting much expected inflation relative to the realised led to persistently upwardly sloped curves.
The current world looks very different. Bond allocations must evolve to shorter maturities and less duration with greater flexibility along the curve and more dynamic allocation.
