BlackRock’s Rieder on Yield Curve, Federal Reserve Rate Hikes

Rick Rieder of BlackRock writing, being patient on interest rate exposure makes sense, but dipping a toe on these historically attractive real rates makes sense to us. Rick joins us now for more. Rick, good to see you, buddy. Every time I see you, you seem happy, and the bond markets fall into pieces. Just explain why. Why do you like this? So, by the way, I'm I'm, I'm doing this from Saskatchewan, which is a good cool place to be. So, anyway, thank you guys for having me. The... So listen. I mean, this is, I mean, this is historic. I mean, I've waited decades for for these real rates and to be able to create income at these level... Your... Levels you're buying fixed income assets with the risk free rate really high. And so... Listen. I... You know, we manage our interest rate exposure. Like, I don't I don't feel like the back end of the yield curve today has given us such a great opportunity, but the front end of the curve to keep your volatility down, keep your income high is is still very attractive today. So listen. I think, you know, part of what, you know, our funds are actually doing okay. Mean, we're up money in a year. The fixed income is down. You gotta manage your interest rate exposure. You gotta keep your back end interest rate risk flow, but the income is incredible. The carry you get from buying these assets. I mean, you could buy high yield at eight, eight and a half percent. Two thirds of that yield is coming from the risk free rate. We had nine years of negative interest rates in Europe as you remember. Like, these are pretty good levels. Again, I'm not saying let's jump in and buy the back end of the yield curve. Let's jump in and buy buy long term interest rates. But for creating income, it's phenomenal. Well, Rick, let's just talk about what's been happening in credit, and you alluded to some of it. Spreads are still pretty tight. High yield's still around 300 basis points. Had a bit of a repricing recently, but all in yields are very, very high because the big move we've seen in the so called risk free rate. Now, Rick, some people might suggest that you've seen the price adjustment to the risk around the and the story that's informing those higher rates, but you haven't seen it in the credit, and that's the next leg of this. What would you say back? So so I think it's a great question. You know, I would say a couple of things. One, I do think, and I think Lisa referred to this, you are seeing and, you know, some rollover financing risk in parts of the leveraged loan market. You are seeing some rollover financing risk in parts of commercial real estate. And, yes, you will see more of that going forward. If you take... And and by the way, there's a pretty good opportunity today to upgrade your quality when yields move higher like this. You know, we've reduced some of our high yield and moved into investment grade credit because, gosh, you're hitting yield levels now. I can increase my convexity of the portfolio. I can increase my quality of the portfolio and feel pretty comfortable that I'm flipping that yield. But listen. I don't think if you got an economy growing at nominal GDP of six plus percent, our nowcast is considerably faster than that. It's pretty hard to anticipate a significant default cycle that will press spreads wider. So I think these yields are very attractive. Like I say, at the margin, we've reduced some of our lower quality. We definitely are, are sensitive to parts of the leverage low market, parts of commercial real estate, and particularly going down the cap stack and things like commercial real estate. But I'm not... I don't think we're seeing a default cycle coming, and and you have pension fund life insurance companies. You hit these yield levels, and they're pretty darn attractive to... And I... And, you know, I'll say one thing about the equity market. You know, people ask, is there a point where the ten year really chokes the equity market? I don't think there's a level. But, you know, for years, we talked about this Tina thing, and I was talking about Tiava now. Like, there is a big alternative. Like, you can now create a 7% yield without that much dispersion, without that much interest rate exposure. You can run less than three years of interest rate exposure with duration, and that's a pretty good alternative to equities. And so you're starting to see some people look at that. You're starting to see some pensions, some foundations that are that are that are evolving that a bit. I'm wondering, Rick, do you think that you would prefer to take investment grade credit risk over sovereign risk in developed economies? It's a great question. So, in fact, in many places, yes. The, you know, in... You know, we've been doing it more in US investment grade. Listen. I think I think European investment grade is just... Is okay today. I do worry about some pressure in some of the sovereign. We talked about France. You talked about, you know, potentially Italy. You saw some real pressure on that last week. So my sense is, gosh, I don't have that dilemma in The US, so I've been adding some US investment grade. By the way, I'm say one thing that Jonathan said. You know, people talk about, like, why why are yields moving higher? We are... If... I mean, the war is a big deal. Crude oil is a big deal, obviously. The amount of supply that's coming, and one of the things that's pretty attractive, a lot of the supply that's gonna come is less price sensitive than it's been historically. And so the idea that, gosh, I can get some of this new issue at attractive levels because they're indiscriminate as to price, that's pretty attractive today. But it's also... You know, it it certainly puts pressure on the overall real rate, which, which I think is quite fair. The competition for capital that so many people have talked about. Rick, you said earlier that you're not interested in duration and that even though you do find certain yields at the front end attractive, you're still staying away from duration. What would make you interested in long term benchmark interest rate instruments? So she's, you know, I will say one thing. I... There's not a yield. Although, I I have to say, you know, if you look at history and you say, gosh, when you get behind a 5%, you know, 95% of the time you make money and the average return is nine and a half percent. That being said, you make more money when it's at five and a half to six. So I'm not sure we have to jump in quite yet with with, obviously, the war growth, what it is, the supply, what it is. So there's not a specific level today. There is a... There are a couple of things. One, if you had some improvement in in the Mideast, that would be significant. The second thing, listen. I... I'm... And I've said this before on the show. I don't think that moving the front end of the yield curve up will keep the back end down. I don't really agree with this. You gotta get credibility. I actually think the Fed at some point has to say something about there's a level that they would use their tools. There was a level that they would look to, contain where long term yields are because the fact of the matter is real financing in modern capital markets, Real financing doesn't happen at the overnight funds rate. It happens out the yield curve. You think about the mortgage market, the credit market, the securitization market, it happens further out the yield curve. Moving the front end of the yield curve just doesn't have the effect on inflation, doesn't have the effect on financial velocity it has historically. Are we gonna slow GPU purchasing because the funds rate is up another 25 basis points? I mean, it's... To me, it doesn't make a lot of sense. I just think long term financing has to be... At some point, has to be contained, And I think that's the tools are at the Fed to do that. And, Rick, did you just say yield curve control without saying yield curve control? Yeah. I mean, I... Listen. I mean, I don't mind calling it that. I think I think at the end of the day, you know, it gets in our controversial debate, but I think at the end of the day... And I thought Lisa brought up a great point before. How much do you want long term interest rates? I mean, what really long term interest rates affect our our borrowers and the housing market, small business, low income. And they... And the fact that these... You know, to contain data center spend or GPU spend, the pain you'd put on so many of the people in this country doesn't make a lot of sense to me. So, you know, that's part of why I think it's a bit archaic to think about, gosh. We gotta move the Fed funds rate up to get inflation down. I just don't think it really works. Rick, by last point, I think so many of our audience will have sympathy with that view A lot of this doesn't make sense right now, that the source of inflation and much of this robust growth is coming from a part of the economy that is largely, not totally, but largely rate insensitive, and that all you're gonna be doing between now and the next twelve months is beating up the parts of the economy that are already beaten up. Rick, the issue I have, though, it's not how you and I think it should be. It's how it will be. You were close to being in charge of how it will be, but, ultimately, we're both on the outside looking in. How do you think it will be in this institution? So it's a great question. So listen. I've been... I've learned in my career. Like, know, the point you said about inflation, if you break down PCE inflation, it's oil prices, it's energy, and it's semiconductor prices. I'm pretty certain that the funds rate's not gonna address that. Then you look at service level inflation, which is what gets in a core PC. You look at education, health care, insurance, pretty darn hard to get at that through the through the Fed funds rate. So listen. I wouldn't I wouldn't raise the rate. That being said, I'm positioned for what is a hawkish Fed and a and a Fed that is going to... That is gonna move. I think they're... I think they'll skip October. I think they'll move again in December. I think as you get into next year, I mean, we have growth coming off the boil. We have inflation coming down. By the way, the last three months, six month moving average of core PCE, core CPIs, and the... It's in the low two... Low to mid twos. So, you know, I think you you can get... You'll get a hike in December, and then I think you can slow it down. But, that's what I think will happen. But for today, with all of the the shocks to the system, I think you gotta be conservative about your interest rate exposure. I... You have to be moderate in terms of any interest rate exposure you take and just flip coupon and and flip coupon and be happy. Think that was the... That's the idea. Flip coupon and be happy at the same time that potentially the only way that you would get into longer term duration would be if the Fed freaks out and essentially expands its balance sheet deals with a yield curve control in some capacity. I just wonder, at what point does the sell off in long term rates threaten the corporate story considering that at some point, they're gonna struggle to pay this back? So Lisa said one thing about the math of the balance sheet. 89% of the debt in The United States is two years and then we roll over. Part of why the interest expense of the country will keep going higher is as you keep moving the funds rate up, we're gonna keep rolling over front end debt, and it's gonna compound the debt problem in the country. You actually don't have to expand because there's not that much notional size in the long end of the yield curve to actually purchase. And if you actually take the the duration of the d v o one that sits out in the back end that's held on the Fed's balance sheet, on the pension funds balance sheet, on insurance companies, actually don't think you have to expand the balance sheet to actually do that because of the math of the front the front versus the back end. You know, where where does it impact the corporate market? Listen. I... You you are definitely seeing more companies and and that's data center and that's others that are that are at least thinking about these rate levels. You know, what you're seeing today, there is some real supply that's gonna come because people are worried they're going higher. And so there's... So you have the near term supply effect, Part of why I've been adding to investment grade versus things like agency mortgages, things like high yield is is quite frankly, I think the... Yeah. Think these are gonna be some pretty attractive financing levels when you look a year from now and think about, gosh. I mean, high quality. It fits insurance companies. By the way, the other the other area that's interesting is emerging markets are in a very different paradigm than developed markets. If the currency, the dollar stays relatively stable, your yield in EM. And many of the EM countries are actually starting to get over the hump on inflation that EM is an interesting way to supplement your portfolio today without as much DM duration risk. Right. Just to sit on treasury just for one further beat. Are still on the borrowing advisory committee? No, sir. I I timed out on that many, many years ago. The reason the reason I ask is I take has taken me. I I just wonder. I remember you used to be. I I just wonder how you would feel the next QRA, quarterly refunding announcement if they really cut supply at the long end, whether that would get you interested in buying some of that debt. It would not. And so I don't... You know, personally, I've heard that argument that we should cut out debt in the back end of the curve and just issue in the front. I personally don't think that would be an an enticing experience. The biggest problem I have is that is... Well, one of the bigger problems that has been created for many, many years is the term structure of our debt's too short. We have to extend the way on... We have to extend the weighted average maturity of our debt. And so the idea, like, we're gonna cut out long bond auctions because we have a near term paradigm, some of which created by the war, and we're gonna disrupt the regular and predictable auction schedule of The United States. I don't think that's an effective vehicle to bring, and it's part of why I don't think the treasury's tools to do that, you know, long term, medium term that make a lot of sense. I, you know, I'd rather see... Quite frankly, I'd rather see a a predictable, let's extend the wham, let's create stability in our debt structure so we know the currency will be consistent and stable over time. And that to me just strikes me as more pragmatic and more thoughtful longer term. Do you think we are disrupting the regular and predictable nature that we typically associate with supply coming from treasury? No. I don't... Not today. I don't think so. No. Don't I don't I don't think so. I think I don't think the auction schedules are what they are. I will say, the point you made earlier, I watched these thirty year auctions like a hawk, yeah, and ten year auctions like a hawk and was, as I say, a bit encouraged by yesterday. But, you know, we got a lot of debt that we got. And we're we're gonna roll, what is it, 520,000,000,000 a week of debt in The United States. You know, we gotta keep, you know, we gotta keep back end financing, you know, at at reasonable levels. And by the way, I I don't think this this rate dynamic is unstable today. I think it's pricing in pretty spectacular growth in the near term. And so so I know. So I think I think I think that is I think that is fine. Rick, before you go, where is that demand gonna come from the issuance coming at the long end? And can we depend on foreigners in the way we used to depend on that foreign bid given developments that might be on the horizon in places like Japan? Mean, do you hit the nail on that? I mean, no. The answer is no. You know, because of the cross currency swap in Japan, because of the relative attractiveness, JGVs... By the way, I like long end JGVs as a... The carry I get in JGVs is pretty interesting. So... And then in, obviously, in China, the size of the demand, whether the demand is going down or there's no demand. So I think it's a domestic. You gotta fund it domestically. Listen. You know, people underestimate though, you know, a point I made earlier. There is not that much. I would say the reason why people all have the steepener or put the steepener trade on and they get squeezed out of the trade is it's actually not that much net duration sitting out the curve. And so at some point, when the economy... Let's say, you know, god willing, you know, you get some better stability around the Mideast, and then the growth of the economy starts to moderate, which I think you'll start to see over the coming months and and quarters. All of a sudden, there'll be people who wanna buy the... Ourselves included. We'll we'll we'll want to buy the back end of the yield curve and to buy and to buy interest... Take more interest rate exposure. But I think you start to have to see that manifest itself before before you see it of any significant size. Just