For a long time, one acronym reigned supreme on Wall Street — TINA, or “there is no alternative,” which was used to talk about the allure of stocks in a low interest-rate environment. But now, BARB — or “bonds are back” — is the new queen.
That’s according to Gargi Chaudhuri, head of investment strategy for the Americas at BlackRock’s iShares unit. She joined this week’s “What Goes Up” podcast to talk about her 2023 outlook, next week’s policy decision by the Federal Reserve and the appeal of not only safe Treasuries but also some riskier mortgage securities.
“We lived in a decade and a half of the TINA world,” she said. “And now it is so exciting, I think, to be in a world where there are some incredible opportunities staying very high in quality, short in duration, in the fixed-income markets and on yields that we could have only dreamed about because bonds are back — because it’s BARB.”
Here are some highlights of the conversation, which have been condensed and lightly edited for clarity. Click below to listen to the full podcast, or subscribe on Apple Podcasts or wherever you listen.
Q: What are you expecting next week from the Fed?
A: Next week will probably be all about inflation. I know we want it to be about the Fed, but I think it’ll be about inflation. As of right now, the market is expecting one more weak-ish CPI print. So think about perhaps a 0.3% on core. Anything that looks higher than that, so if we get another 0.4% or even a strong 0.3% with a strong core ex-shelter — so remember now the market will be extremely focused on that core ex-shelter piece because Chair Powell has brought that up — and now we’re going to be just uniformly focused on that one line item. And I think if we get a stronger-than-expected number on that core ex-shelter, that could negatively impact risk sentiment.
And then with the Fed, a 50 basis-point hike is baked in. But more important than that 50 basis points is actually how they project their SEP forecast. So what are they telling us about the path of policy for the next two years? How are they guiding us about inflation? And also how Chair Powell is perceived from a hawkish perspective. Is Chair Powell going to be a little bit more hawkish this time around at the December meeting? I don’t think so, but I think that’s what the market’s going to focus on — to what extent does he talk about double-sided risks versus to what extent does he talk just about “more needs to be done.”
Q: You said in your outlook that Fed easing is unlikely in 2023 because inflation will keep persistent, right?
A: That’s actually really one of the core themes as we think about the market for the next year. This idea that we’re already pricing in some cuts for the end of 2023 is a little bit optimistic. The Fed has told us again and again — whether the market wants to believe it or not — that they are looking to keep rates higher for longer. That’s what they want. And our view is at least that both core CPI and PCE inflation — which as we know the Fed looks at, their preferred measure to look at PCE — both of those will stay significantly above the 2% target. And in a world where unemployment is still, at this juncture, much below 4%, it’s at 3.7%, and looking ahead probably still remains much below their assumption of NARU [natural rate of unemployment], it’s a little too optimistic to expect meaningful eases for 2023. I think we get to 5%, maybe 5.25%, and then just stop. We let the monetary policy and its lagged effects work. The market prices that in sometimes and then comes all the way back, and then the Fed pushes back and they price that in, and then come all the way back. So there’s a little bit of that tug of war with the markets and the pricing of policy for the remainder of the year. But I doubt that they are going to cut 50 or so basis points — maybe in 2024, but I doubt that’ll happen next year. Maybe one at the end of the year, but no more than that.
Q: So bonds are back? BARB?
A: It is so exciting to be in a world where there are some incredible opportunities staying very high in quality, short in duration, in the fixed income markets and on yields that we could have only dreamed about because bonds are back — because it’s BARB. And I’m talking two-year Treasuries here, I’m talking one-to-five-year IG credit, something like an IGSB or something like a SHY or even mortgages, something like an MBB, which can earn you about 4.6% yield without taking too much credit risk, staying very up in quality and earning significant yield in your portfolio — and especially having that in a world where growth is going to slow down. Now whether we’re immediately going to fall into a recession or not, we don’t know. The signs are showing a recession. But even without all of that, owning bonds in your portfolio where you’ve historically been 60/40 to equities, I wonder if you’re supposed to be 60/40 to bonds.
Q: Let’s unpack your thinking on MBB. When people hear mortgages, there’s a little bit of fear. If we do have a deeper recession than people are worried about, if we do see an uptick in unemployment, how risky are mortgages?
A: Whenever we hear the word housing, we think great financial crisis. And I completely hear that. And I would say that the dynamics of the housing market now, the dynamics of the mortgage market now, are so different from what 2007 was because 2007 taught us some very good, hard-earned lessons around what it means to have a stronger, more regulatory-induced mortgage market. And all of that has led us to a world now where, of course, it’s much more difficult to get mortgages. And look, are housing prices going to come back lower from here? For sure. I think we are going to see some of that if the unemployment rate does go up from here. Is it possible to see further pressure on the housing market? Absolutely. But does that mean that we’re going back to the foreclosures and exactly the same kind of outcome that we saw in 2007? The answer is no, because it’s a structurally different market. There’s a lot less supply of homes, a lot more demand. There are a lot more people that are entering that 30-to-35 age bracket in the US that will be needing to form households, that’ll need to own homes.
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