Readying bond portfolios for reflation

We believe now is a good time to ready bond portfolios for global reflation. Richard explains, with the help of this week's chart.

We believe now is a good time to ready bond portfolios for reflation: improving growth, wage gains and higher inflation. We see global reflation running further in 2017 and spurring a modest rise in global bond yields.

008062A_US1_Weekly_Email_V3

Consumers and businesses around the world are gaining confidence, as this week’s chart shows, possibly awakening animal spirits. It is not just a U.S. phenomenon; the synchronized nature of this cyclical upswing makes it different from previous false dawns, as detailed in our January Global Macro Outlook. The key to our outlook: Stronger confidence needs to start translating into higher consumption and investment.

Our fixed income base case

The rise of U.S. wage growth last month to its highest annual rate since 2009 suggests the reflationary phase of this economic cycle has finally arrived. This economic backdrop was reinforced after Donald Trump’s surprise presidential victory opened the way for potentially game-changing tax and regulatory reforms. How and when any reforms are implemented are likely to be key drivers of financial markets this year.

Our base case: Moderately improving U.S. and global growth accompanied by tame inflation will lead to gradually rising long-term bond yields. We see U.S. yields remaining below historical averages, with further rises likely in line with Federal Reserve (Fed) rate increases. A risk to bonds would be the Fed pressing ahead faster than our expected pace of two-to-three rate rises this year.

We like inflation-protected Treasuries (TIPS) instead of nominal bonds, favor shortening interest rate exposure and favor more corporate credit. We prefer higher-quality investment-grade issues as well as financial paper in both Europe (Tier 1) and the U.S. (bank preferreds).

Key elections in France and Germany and the possibility of decreasing monetary policy support the potential for higher yields in the eurozone, particularly in peripheral countries. Global reflation should be positive for emerging market economies, yet the potential fallout from a stronger U.S. dollar keeps us cautiously selective. Read more market insights in my Weekly Commentary.

Richard Turnill is BlackRock’s global chief investment strategist. He is a regular contributor to The Blog.

Investing involves risks, including possible loss of principal.

International investing involves special risks including, but not limited to currency fluctuations, illiquidity and volatility. These risks may be heightened for investments in emerging markets. Fixed income risks include interest-rate and credit risk. Typically, when interest rates rise, there is a corresponding decline in bond values. Credit risk refers to the possibility that the bond issuer will not be able to make principal and interest payments.

This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of January 2017 and may change as subsequent conditions vary. The information and opinions contained in this post are derived from proprietary and nonproprietary sources deemed by BlackRock to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by BlackRock, its officers, employees or agents. This post may contain “forward-looking” information that is not purely historical in nature. Such information may include, among other things, projections and forecasts. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this post is at the sole discretion of the reader.

©2017 BlackRock, Inc. All rights reserved. BLACKROCK is a registered trademark of BlackRock, Inc., or its subsidiaries in the United States and elsewhere. All other marks are the property of their respective owners.

USR-11427

Join the Conversation

How are you preparing your portfolio for reflation? How are you preparing your portfolio for reflation? Join in >