For BlackRock’s Rick Rieder, there is one story that defines markets in 2018 — the front-end of the Treasury yield curve.
“Full stop, if you said to me, ‘What is the story of the year?’ For investing, what is the story of 2018? It’s the front end of the yield curve moving higher,” Rieder told Yahoo Finance in an interview.
Rieder, the chief investment officer of global fixed income at BlackRock, said that after the crisis one of the dominant themes in markets was TINA — There Is No Alternative.
This idea pushed many investors into riskier assets after the financial crisis like the stock market or high-yield bond market in order to generate returns as interest rates traded at historic lows and trillions in government bonds traded at effective yields below 0%.
“Now there’s a big alternative,” Rieder said. “And by the way, it’s really attractive.”
At the outset of 2018, six-month Treasury bills were yielding 1.53% while two-year Treasury notes, traded at a yield of 1.92%. As of Friday’s close, six-month bills were trading at a yield of 2.19% while two-years were at 2.69%.
And this increase in the nominal return that investors can get for buying assets considered the safest in the world changes a huge series of assumptions investors had been making during the post-crisis years when easy money policies were being almost uniformly pursued around the world.
“So if you think about it,” Rieder said, “I could buy two-year Treasuries at a 2.62% yield today and I don’t have to take credit risk, I don’t have to take yield curve risk, I don’t have to take long-end interest rate risk, and I can do this…and I can get over a 3% spread and I can sleep well at night? I feel pretty good [about that].”
‘One of the more interesting economic growths we’ve ever seen’
Yahoo Finance spoke with Rieder on July 27th, just a few hours after the BEA reported the U.S. economy grew at an annualized rate of 4.1% in the second three months of 2018.
“This is one of the more interesting economic growths we’ve ever seen in that you’re getting this extraordinary burst of growth today,” Rieder said. “Think about it, over 4% real GDP and over 6% nominal GDP. It’s a pretty impressive number.”
But this burst of growth isn’t likely to continue beyond this year in Rieder’s view, setting up the Fed to slow down its pace of interest rate increases beginning in 2019.
“We think [the U.S. economy is] going to end the year with well over 3% growth for the year,” Rieder said. “It’s really impressive. But some of what’s happening is you’re getting the capital expenditures that have been growing based on the tax bill encouraging companies to do that… But it’s creating something that’s really interesting. Meaning, you’re going to grow very quickly and then you’re going to start to slow.”
“This is where the Fed is in a bit of a tricky spot,” Rieder added. “So they’ll move. We think they’ll raise rates in September and again in December. But then they’re going to have think about an economy that could slow from these pretty impressive levels today.”
Markets currently expect the Fed to raise interest rates two more times this year and the Fed’s dot plot suggests three more rate hikes are coming in 2019. This would put the effective Fed Funds rate north of 3%, above the level the Fed currently expects will prevail in the long run.
And the Fed putting its benchmark interest rate target above where it believes long-term rates will likely settle would officially make the Fed’s policy stance one in which it is trying to restrict economic growth and stave off inflationary pressures.
An economy that slows on its own following the tax cut-induced growth we’re enjoying in 2018, however, could incentivize the Fed to stop short of an outright restrictive policy stance.
This scenario Rieder outlines sets up an economic quagmire for President Donald Trump to potentially navigate into the later half of his presidential term.
On Friday, Trump said his administration has “accomplished an economic turnaround of historic proportions.” Trump added that, “The most important thing is these [GDP numbers] are sustainable. This isn’t a one-time shot. I happen to think we’re going to do extraordinarily well in our next report…I think the numbers are going to be outstanding.”
Earlier this month, however, Trump had been critical of Fed policy, saying on Twitter that, “Tightening now hurts all that we have done. The U.S. should be allowed to recapture what was lost due to illegal currency manipulation and BAD Trade Deals. Debt coming due & we are raising rates – Really?”
This tweet followed comments Trump made in an interview with CNBC when he said, “I’m not thrilled” about the Fed’s recent decisions to raise interest rates. Since Trump was elected in November 2016, the Fed has raised rates six times. Last year, Trump said in an interview with the Wall Street Journal that he does favor a low interest rate policy.
While Trump told CNBC his comments about the Fed are how he would feel as a private citizen and he was not trying to influence Fed policy, the conflicting realities of a U.S. economy in which growth slows after the boost from tax cuts wears off could see Trump get his wish.
“I think the long term interest rate that’s close to equilibrium, in this economy, with these demographics…is closer to 2%,” Rieder said.
“So once you start to get up to 2.5%-2.75%, I don’t think the Fed — particularly in an economy that may start slowing — is going to get chased into thinking, ‘Gosh we have to move faster, we have to move further.’ They’ll watch the data and determine; do they have to go any further? But I think it’s going to be questionable whether they feel like they have to be restrictive.
“Just get to equilibrium and leave it there.”
Myles Udland is a writer at Yahoo Finance. Follow him on Twitter @MylesUdland