September’s strong jobs report, along with the (not surprising) upward revision to August’s employment data, confirmed my expectations that a Federal Reserve (Fed) rate hike is likely to come earlier than many expect.
The report provided further evidence that the U.S. labor market is recovering at a healthy clip, and taken together with recent real gross domestic product (GDP) data, it’s clear that the economy is running more strongly than many have been willing to admit.
As such, maintaining monetary policy accommodation at “emergency levels” appears both unnecessary and potentially disruptive to the proper functioning of financial markets today. So, it’s increasingly likely that the Fed may begin raising policy rate levels by the end of the first quarter of 2015.
Given all of the noise in the fixed income market over the last week, however, you may be wondering what my interpretation of this latest report means for your bond portfolio. I see three potential investment opportunities.
Favor longer-dated Treasuries over those with two- to five-year durations. Looking forward, U.S. interest rates should drift higher (at BlackRock, our year-end target for the 10-Year Treasury is around 3%), and I continue to be convinced that rates are likely to be led by the front-end of the curve. Of course, the various headline-grabbing geopolitical risks that have come up in recent months may delay this process, but the eventual trajectory of rates is higher.
Still, the extent of any rate rise should remain modest at the long-end, as the yield curve flattens further. Therefore, I continue to view longer-dated Treasuries as a potential opportunity, particularly if their yields rise over the coming weeks. At the same time, however, the two- to five-year portion of the Treasury curve is likely to exhibit the most volatility and be most vulnerable to rising rates.
Look to select areas of emerging market (EM) debt. Select areas of the EM debt sector hold good potential, as many of these countries exhibit low leverage levels and are currently funded through year-end. We prefer hard-currency USD/euro EM bonds and select EM issues that may offer relatively attractive yields.
Consider total return-oriented and opportunistic strategies. In today’s environment of moderately rising (albeit still historically low) rates and tight spreads, we at BlackRock believe that investors should consider allocating at least a portion of their fixed income portfolios to balanced approaches, as well as to flexible, go-anywhere investing strategies that look for opportunities across a wide set of asset classes and global markets, adjusting duration and rate exposure as needed. Such investing approaches can potentially help investors mitigate interest rate risk and protect against market shocks.