'Keep Your Bonds Safe:' What to Watch in Fixed Income Following Fed Rate Hike

Sam (0:01)

Thanks very much for that, Mali. Joining me now here at the desk to discuss the Fed policy and its impact on the bond market is Karen Veraa-Perry, head of US iShares fixed income strategy over at Blackrock. Karen, thank you so much for your time this afternoon.

Karen Veraa-Perry (0:12)

Thanks for having me today, Sam.

Sam (0:13)

All right, what the Fed did last week with this hike, I had an interesting conversation with someone this morning, even though the market seemingly pushed the Fed into having to make that decision. Some say it's irrelevant because it still exacerbates the struggles of those who are not coping so well, and it doesn't go far enough perhaps to fight the inflation beast because obviously it's a supply-driven shock that we're dealing with. What's your take on all of this?

Karen Veraa-Perry (0:40)

Yeah, I think you're absolutely right. The Fed started, the market started pricing in hikes way before they were even signalling them with the Fed speak. But I think their goal is to really be credible in inflation and be more hawkish. So what we're going to see is our base case is they might hike one more time this year, and there's probably a 70% chance using the Fed Fund's future market.

So while they were a little bit backed into a corner, we also think that given where the inflation prints have come in and the energy prices have been driving a lot of that, this is at least a step in the right direction to get inflation a little bit more under control from the demand side of it at least.

Sam (1:16)

So two hikes potentially, and they have signaled that they could go again this year at least before we see 2026 is out. What would be the impact then, do you think? I mean, what would be the intent? Is it beyond trying to just get rid of the insurance cuts that were made?

Karen Veraa-Perry (1:34)

Yeah, I think they're hoping that once we get a couple more rate hikes in the system, inflation calms down a little bit, and they're hoping that the jobs market is not as negatively impacted. So we're still seeing a strong jobs number, good corporate earnings, consumer spending is still up.

So the terminal rate, they think 4.6 was based on the dot plot, but then they want to get that back down to the threes. So I think for fixed income investors, let's take advantage of this opportunity. There's higher income levels in the market. So we're seeing some people doing some interesting things. They're tax lost harvesting, they're then allocating to floating rate exposures. I think there's just more opportunity for fixing investors now.

Sam (2:09)

Yeah, talk to me about that because when I ask investors about how they're diversifying, they do say they are looking at bonds. Where are you seeing the most flows right now as far as demand and appetite?

Karen Veraa-Perry (2:20)

Yeah, we're still seeing the most flows coming into shorter duration exposures and government exposures following that broad market ETFs like AGG.

But then for some people who do want a little more bang for your buck, convertible bonds have equity-like upside, big technology presence. I see BTR, convertible bond ETF is getting some interest. So I think that if you're looking at your bond portfolio, you can easily get 5%, 6% yields without having to take on a lot of risk. And that's really where people are trying to structure that income and that range.

Sam (2:51)

What are you seeing as far as appetite for duration right now? I mean, given the levels we've been looking at every week.

Karen Veraa-Perry (2:56)

Yeah, people are really duration-shy. So if we think about 30 years testing some of those 525s or higher, we've actually launched a couple of ETFs that are 1 to 10 years in maturity. You can get 90% of the income with cutting out all that duration. So we have a new one, Ag M, that's basically the ag without the long-duration bonds. I think that could be suitable for a lot of people who don't want all that volatility from duration.

Sam (3:19)

Where do you see rates heading in the future?

Karen Veraa-Perry (3:22)

Yeah, I think we're probably going to continue to be higher for longer over the near term. I think in 2027, we might see one more rate hike ending about 4.5 on the terminal overnight rate. And then we're hoping that with inflation coming down, that will help bring down some of that term premium in the long term. So I think overall rates will be in this neighborhood, but if not coming down slightly over the near term.