BlackRock Admits The Fed Is Causing "Tremendous Distortions"
BlackRock's fixed income CIO Rick Rieder is worried about the impact that higher rates will have on the stock market. In this brief interview with Bloomberg TV's Tom Keene, Rieder explains that while equities look 'cheap' given where rates are, this is a mis-pricing and warns (as we have repeatedly) that "people don't spend any time looking at cash-flow discounted by cost of financing, which is really where we think equity should be valued." In that case (as we have noted), a surge in financing costs will weigh heavily on stocks. While he is concerned about investors' general lack of awareness of the risk in bond funds - "the volatility in fixed income could actually be higher than the equity market," he fears the impact of higher rates on mortgages and other credit vehicles on the recovery. However, as Rieder notes they have been saying for a long time, "QE’s too big. You’ve got to taper down QE. It's created this tremendous distortion in interest rates," as he sees fair-value for the 10Y around 3.25%.
On Bond Fund volatility:
Yes, it’s bad. It's amazing. As I go around the country and people talk about the safety in bonds. Bonds are different, the volatility. Nobody really understands the volatility in the fixed income market could actually be higher than the equity market. You’ve seen it over the last few months. You’ve seen it very quickly in the last few months.
On interest rate impacts on stocks:
Do you know we’ve been a big believer that you have a mispricing of the debt market versus the equity market. People don’t spend any time looking at cash flow discounted by cost of financing, which is really where I think equity should be valued. You're still – Equities are too cheap relative to where rates are.
If you got a significant move, if rates moved another 50 base points, equities have to feel it.
But as long as we stay in the range – 3% to 3.25%. Next year we’re going to low threes. That being said, as long as you do it in a stable way, and as long as rates drift up, equity markets should be okay. If you did it in a shocked way, like you’ve seen the last few weeks, then you could see pressure in the equities market.
On the unconstrained reach for yield:
So we’ve seen a lot of money flowing into unconstrained bond funds. People have a tremendous feeling around “they need income.” They want to have income. So we’re seeing the money shift, and it's going from what are core, passive bond funds that are very long duration, very long interest rate sensitivity, moving into more unconstrained funds that can get their income in other ways as opposed to just interest rate raise.
And current duration shortening and de-risking:
Yes, but they're going more to unconstrained. They're going to funds that can actually manage it aggressively, can actually go short duration, and it actually generate positive returns in an environment where the rates rise.
On QE and Taper:
No, we’ve been saying for a long time, QE’s too big. You’ve got to taper down QE. It's created this tremendous distortion in interest rates. Most of the losses have come because of distortions coming out. We think fair value in the ten-year, closer to 3%, 3.25%. You're getting pretty close to there, and we’re just starting the tapering.
On Bond fund losses:
We think that you're going to have modestly negative returns in bond funds. You could – certainly in this year and certainly into next.
We’re at the point where people have realized that you can still have significant losses. Munis have had pressure, anything with long interest rate risk. I would argue Detroit has been an issue. I would argue longer interest rate risk has been the problem. Again, it gets to, we’ve distorted interest rates so far down, and we talk about we’re at a 170-180 ten-year. You have distorted interest rates, but what we thought was fair value, over 100 basis points. That's all getting washed out today. Could you overreact more to the downside? Certainly.
On higher rates impacting the economy:
Part of what – We’re going to go into this Fed taper discussion in September. I still think they're going to move down the road of tapering. The hard thing is you’ve shifted rates up so quickly, and mortgage rates. And you can’t have the housing market under pressure.
On the long-term outlook:
Yes, I think there is – People don’t realize if you just stay in a straight passive bond fund, that's worked for 30 years, that – It's worked, and rates have been on a straight line down for the past 30 years. Not in a jagged way.
Now all of a sudden, you’ve got to think about it differently because we’re not going through that cycle again.
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