Today, the Federal Reserve
announced a reduction in its bond buying
known as quantitative easing (QE). While bond markets barely
budged, stock markets rallied strongly following the
announcement. The step back signals the Fed's confidence
that the economy is on firmer footing while at the same time
reinforcing its goals to keep monetary policy - in the form of
zero interest rates - low for longer.
The specifics of the plan are
, but the headline is a $10 billion/month reduction in purchases
of Treasury bonds and mortgage-backed securities.
What does this mean?
Not a big shock.
This won't be a big shock for bonds, because there's still
plenty of "easy money" in the global financial system as the
Fed promised again today. That's not to say interest rates
won't move higher over time. We are looking for the 10-year
U.S. Treasury to rise by around 50 basis points (0.5%) on
the back of stronger growth next year.
Low for Longer.
It's important to note that while the bond-buying program will
be slowed, to avoid negative economic consequences of a sharp
rise in rates, the Fed will likely keep the short-term fed
funds rate low for an extended time. This is the "sugar" in the
Fed's communications-a point I described in
December's Fixed Income Market Strategy
Inflation should remain muted.
Given the continued slow growth nature of the recovery,
inflation, now at a four-year low in the United States, is
likely to stay low at least through 2014 though we expect some
modest increases next year.
What does this mean for bond investors?
We would suggest:
Shift out of traditional bonds.
Traditional bonds could experience losses.
Traditional bond funds as in those found in the Morningstar
Intermediate Bond Category still carry too much duration risk
such that a 0.5% rise in rates could mean a 2.5% loss in
principal effectively negating any income gains.
Inflation protection is expensive.
Since the rate of inflation is near flat, bonds designed to
protect against loss of value to inflation, such as Treasury
Inflation Protected Securities (
), are not worth owning. But longer maturity TIPS recent
re-pricing makes that area of fixed income attractive. Consider
more flexible allocations that can differentiate investments
across the maturity spectrum.
Focus on credit.
Bonds that trade based on credit, or the ability of the issuer
to pay back its obligations, can diversify a portfolio from the
risks of rising interest rates. While not inexpensive, credit
spread sectors - high yield, commercial mortgages and other
asset-backed bonds as well as longer-dated municipal bonds -
are all still better bets than Treasuries.
Jeffrey Rosenberg, Managing Director, is BlackRock's
Chief Investment Strategist for Fixed Income, and a
regular contributor to
You can find more of his posts
The opinions expressed are those of Jeffrey Rosenberg as of
12/18/13 and are subject to change at any time due to changes
in market or economic conditions. The comments should not be
construed as a recommendation of any individual holdings or
Bonds and bond funds will decrease in value as interest
rates rise and are subject to credit risk, which refers to the
possibility that the debt issuers may not be able to make
principal and interest payments or may have their debt
downgraded by ratings agencies.