FAE Speakers: Fed Plan Sparks Concerns About Fixed Income

By:
CHRIS GAETANO
Published Date:
Aug 5, 2014

“You should run.”

That’s what BlackRock’s managing director and chief investment strategist for fixed income, Jeffrey Rosenberg, told a group of CFOs and other financial professionals looking to navigate the fixed- income environment at the recent Foundation for Accounting Education’s CFO’s, Controllers, Treasurers, and Financial Professionals Conference in New York City.

According to Rosenberg, in the wake of the most recent financial crisis, fixed income no longer seems all that fixed, as new realities transform the market and upend traditional growth opportunities.

Rosenberg was among a trio of leaders from influential financial institutions to speak at the conference, which included James E. Glassman, the managing director and head economist at JPMorgan Chase & Co., and Mary Ann C. Bartels, the chief investment officer of portfolio strategies for global wealth at Bank of America Merrill Lynch.

To help stabilize the economy during the 2008 financial crisis, the Federal Reserve reduced the level of short-term interest rates to near zero and made large-scale purchases of assets, such as Treasury bonds, to further suppress them. The Federal Reserve has said it will continue the zero interest-rate policy until 2015, though some have expressed concerns that continued low rates could lead to higher inflation. During a conference session on fixed-income strategies, Rosenberg said that the Fed was operating “with a massively unprecedented degree of financial repression,” and was running “a zero interest-rate policy long after zero interest rates are needed.” This, he added, made the outlook in fixed income “very challenging—at best.”

 With fixed income, Rosenberg explained, it’s critical that the income received off the portfolio exceeds the rate of inflation. If he could offer a portfolio with no risk and a 5 percent yield, he said, investors would be excited, but that wouldn’t be the case if he had extended the same deal in 1979 when inflation was at 12 percent, which would have meant investors were actually losing money.

Rosenberg said that while inflation might be low at the moment, the interest rates are even lower, which translates into a lot of negative returns. This is a fairly rare development, he added, noting that in the past 33 years, there have only been three years where growth was negative in the fixed-income sector. Now, however, it almost seems the norm.

Bartels, who also participated in the session, said that the country hasn’t seen this particular interest rate environment since the Great Depression, although she noted that there was no quantitative easing during that period. She agreed that the zero percent interest rate has savaged the normally stable fixed-income market.

“The fixed-income market had the greatest bull market of your lifetime—a 30-year bull market—and we think over time, rates will trend high as the economy normalizes,” she said. “[But for now], we don’t think you can grow your wealth within the bond market, even though it’s very important for risk reduction and asset allocation.”

Indeed, Rosenberg said that to survive, fixed-income sector investor habits are changing. Fixed-income investors, he said, have reacted to the zero interest-rate environment by switching their  focus to short-term, high-yield areas such as bank loans or other nontraditional sources. In fact, he said, nontraditional is now the fastest growing sector within the fixed-income market.

Still, Rosenberg expressed concern about this change and wondered whether seeking short-term gains is shortsighted. Will investors be setting themself up for another fall, especially considering that the Fed has hinted that it does eventually want to raise interest rates again?

“I don’t love fixed income at a zero interest rate, but the bond refers to the longest maturity instruments within the fixed-income world ... those yields are very close to fair value,” he said. “The longer maturity end of the fixed-income spectrum is where you have some margin of cushion. No one sees that because we look in the rearview mirror … but the way to advise is to look through the front windshield.”

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