The fixed income market doesn't get the same sort of love and attention the equity markets do, but investors shouldn't overlook it. In fact, Gargi Chaudhuri, Head of iShares Investment Strategy at BlackRock, tells Yahoo Finance Live there could be a "generational opportunity" for investors in that market right now.
Video Transcript
JULIE HYMAN: Because we have to talk about another area of the market, Fed Chair Jay Powell still very much in hawkish mode, telling peers in Portugal that with inflation nowhere near the Fed's 2% target, interest rates will have to be higher for longer. That's been his message, of course. Most analysts anticipate another rate hike in July at least. The path there, though, is unclear afterwards.
Chair Powell still has not indicated when the next hike will come. In a quote that caught some people's attention, he said "A strong majority of Committee participants expect that it will be appropriate to raise interest rates two or more times by the end of the year." With the Fed holding tight, investors are looking for the best bets in the coming months. And according to our next guest, that's high quality fixed income. We're bringing back Gargi Chaudhuri, BlackRock's Head of iShares Investment Strategy. So Gargi, when it comes to fixed income, we've had a lot of people enthusiastic about it this year for the first time in a long time because we have seen yields go up.
How enthusiastic do you stay? And where do you go?
GARGI CHAUDHURI: Yes, thank you for this question. I feel like so much of our mid-year outlook is around fixed income. But the questions that we've been getting have been around AI. So, thank you.
You know when there's opportunities like AI, fixed income can sound boring. But the thing is that the best opportunity right now in the market, I would call it a generational opportunity to earn these incredible yields, is actually in probably the most basic part of the fixed income market, which is high quality treasuries, agency mortgages, investment-grade credit, inflation linked bonds. You know, you can sort of own the agg-- the agg, and get about 4.7% yield.
I will say the one thing that not enough people are focusing on is the fact that carry and cushion in the fixed income markets is back. And what I mean by that is this asymmetry of outcomes. So if interest rates rise by 50 to 75-basis points from here on the 10-year part of the curve-- so let's say we go to approximately 4.5%, you would still have basically a zero return. In fact, at 50-basis points higher, you'll be up about 1.4% owning the agg for a year. 75-basis points higher from here is when your returns will be slightly negative.
If we have a 75-basis points lower yield environment and you own the agg, you'll be up about double digits. So that's asymmetry in the market. And why does that exist? That's because bonds are back, cushion is back, carries are back, yields are back. So your coupon is earning you something, which, of course, for the last decade and a half, it didn't.
So when it comes to fixed income, I think owning the 3 to 7-year part of the curve-- so the belly-- is where I think investors should gravitate to so there's a little bit of diversification that you're getting. You're getting a little bit of that ballast. But you're also getting that income.
And I think looking at agg, looking at mortgages, looking at dips might not be as exciting to some investors. But I think it's such a great opportunity right now for every type of investor. I'm buying it in my PA. So I'm really excited about this prospect of owning high quality carry at 5ish percent yield.
BRAD SMITH: You know, one of the great things about keeping too many tabs open is a was able to recall my tab yesterday of the same Fed Watch Total yesterday. We were sitting at about a 74% chance of a hike at the next meeting. You saw it here this morning right there on our screen-- and I believe that was pulled earlier this morning-- sitting at a little over 81%. And actually, more recently now as I refresh as this moves around and fluctuates, of course, sitting at about 89% now.
So all of this coming after Fed Chair Jay Powell comments yesterday. Some of our guests also in agreement yesterday that we could see 50 more basis points to come this year. Are you in that same camp in that, that way of thinking even if we are coming towards the end of this rate cycle?
GARGI CHAUDHURI: Yeah, so I'll start with think about where we were last year at this point. What we were talking about as it pertained to the Fed. We were thinking about the Fed going 75, 75, 50, or 75, 75, 75. Compared to that, right now we're talking about maybe two more rate hikes.
I think the Fed has to keep their optionality as much as possible and keep the options for two more rate hikes on the table, especially if we continue to see strength in the services, and especially the shelter component of inflation, right? I mean, that has been pretty strong. Ex shelter inflation has moderated a little bit, which is good. But shelter, as we know, is about 40% of core CPI. And that's a big number.
So yes, they can go two more times. And I think the Fed is doing a good job by keeping that option on the table for right now because it buys them optionality. Having said that, if they do do that, number one, the market has obviously priced in a lot of that. But number two-- and this is the part that we stress in our mid-year outlook-- is that the Fed is not going to cut rates this year, probably not till the second half of next year as well. I think that's really important for bond investors and equity investors to understand.
So whenever we start seeing rate cuts getting priced in for this year, I think that becomes a little bit harder for me to talk about fixed income. But at this juncture when we are not pricing in any rate cuts, which is going to be the outcome, they are not cutting rates this year. They're going to keep it higher for longer. And yes, if they have to go certainly one more time, I don't know that they'll necessarily go two more times. I think that will depend very much on the data. But even if they do, I think you can still-- again, we talked about that cushion earlier-- you can still have a positive outcome in the 3 to 7-year part.
Again, I wouldn't recommend investors going much longer than that. I don't think you should be buying 30-year yields at this juncture. But I think staying in the belly makes a lot of sense.
