Confused by the Reflation Debate? You've Got Company at BlackRockby
World’s biggest money manager sees yields rising, to a point
Range-bound Treasury market leaves Trump trade in limbo
“I’m pretty confused.”
Those three words last week from Laurence D. Fink, BlackRock Inc.’s chief executive officer, would seem to sum up the feelings of many bond traders.
The global reflation trade has all but flatlined in recent weeks: After reaching a more than two-year high in December, benchmark 10-year Treasury yields have been stuck in a 25-basis-point range in 2017. Even congressional testimony Tuesday from Federal Reserve Chair Janet Yellen, in which she said it’d be “unwise” to wait too long to raise interest rates, failed to jolt the market out of its trading band.
BlackRock, the world’s largest money manager, expects the reflation theme to persist in the months ahead, said Richard Turnill, global chief investment strategist, and Rick Rieder, chief investment officer of global fixed-income. Yet their CEO’s talk of “dark shadows” on the horizon evokes the specter of deflationary pressures across the global economy. It’s perhaps the biggest question in financial markets today: can reflation really take hold with so many forces working against it?
The bond market believes it can, for now. The 10-year breakeven rate, a market measure of inflation expectations, jumped Wednesday to 2.06 percent, near the highest since 2014, after data showing the biggest jump in consumer prices since 2013. Investors have been buying inflation protection at the fastest clip since just after the election. That’s been a boon for Treasury Inflation Protected Securities, which Rieder began purchasing before the November vote. As investors piled into the trade, he pared back, though he still holds more than his benchmark.
U.S. inflation “moving up to these levels, given the technology pressures, is extraordinary,” Rieder said in a telephone interview.
The debate over the sustainability of the reflation trade and the likelihood of significant economic stimulus has far-reaching implications for both investors and policy makers. Richmond Fed President Jeffrey Lacker said Tuesday that the next hike “should come sooner rather than later” because of uncertainty around fiscal measures and climbing inflation.
Rieder predicted the core consumer price index will probably rise to 2.4 percent this year. It’s already close, climbing to 2.3 percent in January, from 2.2 percent year-over-year in December.
Inflation in line with Rieder’s estimates may cap U.S. rates.
“It’s possible we get to a 3.5 percent 10-year yield,” he said. “But it’s hard to envision it getting much higher than that, particularly with the aging population, demographics and the potential for growth in the rest of the developed world.”
In other words, regardless of the reflation debate, something fundamental is changing in the global economy that neither President Trump nor central bankers can reverse -- including the debt overhang many developed nations are grappling with after the recession, the worldwide appetite for fixed-income investments and the evolution of technology that’s altering job prospects.
For now, though, markets are adjusting to what Turnill calls a “very different economic environment,” characterized by data surprises. In China, inflation in January rose 2.5 percent from a year earlier, the fastest since 2014. Yearly price growth in the euro area jumped to 1.8 percent in January, the highest in almost four years.
BlackRock recommends an underweight for regular Treasuries, based on a three-month outlook.
Fink, for his part, said at the Yahoo! Finance All Markets Summit on Feb. 8 that he sees a greater chance that the 10-year U.S. yield dips below 2 percent again, though he also said it could climb to 4 percent. Technological advances and possible global trade disruptions mean deflationary risks remain, he said.
That estimate approximates the range of forecasts collected in a Bloomberg survey showing analysts expect the 10-year yield could be anywhere from 1.75 percent to 4.05 percent by mid-2018.
It’ll probably reach 2.75 percent and move slightly higher, Rieder said. Yet “if there is disappointment on the fiscal front and a view that we’re not going to get progress on fiscal initiatives, there’s no doubt we can trend to lower yields, even approaching 2 percent.”
Until Trump unveils his “phenomenal” tax plan in coming weeks, Treasuries are taking their cues from economic data and Fed expectations. Benchmark 10-year notes yield about 2.52 percent, touching the highest since Jan. 27.