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By Miriam Sjoblom, CFA | 11-14-2012 01:00 PM

Bond Excitement and Concerns for 2013

BlackRock's Rick Rieder expects the bond market to focus more on alpha creation next year, but investors should watch for rising duration risk as well as ongoing troubles in Europe.

Miriam Sjoblom: Hi, I am Miriam Sjoblom, associate director of fixed-income fund research at Morningstar. I'm here today with BlackRock's Rick Rieder who is the chief investment officer of fixed-income fundamental portfolios and also portfolio manager of BlackRock Total Return and Strategic Income Opportunities. Thanks for joining us today Rick.

Rick Rieder: Thank you. Thanks for having me.

Sjoblom: Well, you know there's been a lot going on in the market and a lot of policymaking decisions that have been impacting financial markets. I'd like to get your thoughts on the Federal Reserve's latest announcement of a new QE program, quantitative easing. What is the Fed trying to accomplish and how successful do you think they'll be?

Rieder: I think market participants haven't given it enough credit in terms of the sheer size of it. Whether it's worth the cost, I think we'll learn years from now. The sheer size of it, though, is significant. When you think about it, it's open-ended and they're trying to target a higher nominal gross domestic product and maybe let the line out a bit on inflation to try to get to the point of full employment. The sheer size of what it could be, if you think they're going to keep going in this program, if you think that Operation Twist ends at year-end and then they keep going down the QE program, if it goes into 2014, which I think it could--because getting to full employment is so hard--I think when you actually look at the amount, in 10-year equivalents, that the Fed could buy, it could be literally 2 to 3 times the size of QE1, QE2.

Not only that, it is creating this dynamic in the markets of--if you think about buying mortgages and Treasuries, two thirds of fixed income for the [Barclays Aggregate Bond Index] is mortgages and treasuries--you're creating this dynamic where it is functionally the Fed saying, "I'm going to own two thirds of fixed income. You better figure out something else to do." It's creating this portfolio-rebalancing effect; it's creating this investment in credit--high-yield and investment-grade--it's forcing banks to invest and to lend; it [creates commercial and industrial] lending.

I think time will tell. I think it will create a little bit more inflation than we've had. I have not been worried about inflation the last two or three years. I actually think this will create a little bit of inflation, but I think this is a bigger deal when you see it over time how it plays out. It also has some flexibility to it, but I think it's a bigger deal than markets give it credit for.

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