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By Sumit Desai, CFA | 06-26-2015 12:00 PM

BlackRock's Rieder on Today's Bond Market

The bond manager shares his take on when the Fed will raise rates, inflation, divergent central bank policies around the globe, and the importance of diversification within a bond portfolio.

Sumit Desai: Hi, I'm Sumit Desai, senior fixed-income analyst with Morningstar's manager research team. Joining me today is Rick Rieder, chief investment officer of Fundamental Fixed Income for BlackRock. He's a lead portfolio manager for BlackRock Total Return (MAHQX) and BlackRock Strategic Income Opportunities (BSIIX), both Bronze-rated funds.

Rick, thank you for joining me today.

Rick Rieder: Thanks for having me. I appreciate it.

Desai: Rick, obviously, the hot topic for all bond investors right now is the Federal Reserve and their expectations for when they'll raise rates. What is your view on the Federal Reserve? What are your expectations?

Rieder: I think there are a couple of things that the Fed has said that you have to take at face value. Number one is that they are going to be data-dependent--no doubt they are going to be data-dependent. Number two is they are going to be gradual in their process. Then, you try to take that and say, "What is uncertain from here until when they [raise rates]?" We think the payroll data is going to be good. And I truly think that we've hit the employment numbers that the Fed needs to see. As long as there's a reasonable 200,000 or so jobs [being created each month], then I think the Fed can move in September. Our best guess is that they move in September. The key to focus on is wages and some of the inflation data, because that still hasn't hit their goals, per se.

So, I think they are going to move in September. I think the data could have allowed them to move earlier, but I think they are going to go in September. But I think the most important thing to think about, with regard to when the Fed moves or how the Fed moves, is not so much the when but the pace. And they cannot be any more vocal in their opinion that they are going to be gradual. I think Janet Yellen used the word 'gradual' 14 times in a presentation recently.

I think what they are going to do is they'll move 25 basis points in September. Maybe they'll wait till December, although I don't think so. Then, they'll watch the data after that and move again, but I am convinced there is no path. We are going to move 25, then move another 25 in December, and then move another 25. I think it's going to be very data-sensitive. We think the data is going to be better and will give them a chance to move, and we'll continue down this path of getting the funds rate closer to 1%.

Desai: You mentioned inflation expectations. What are your expectations for inflation? I think there are a lot of competing factors--oil prices going one way and wages maybe potentially going the other way. How do you think the Fed navigates that and how do you navigate that?

Rieder: I think we are in a really different world from anything we've ever seen before. I think that we grossly underestimate technology's impact on inflation. I truly think the way data is measured is faulty. I think when we get the nominal aggregate GDP data or retail sales, it's this conglomeration of industries that are changing radically--energy is one you mentioned. If you think about how technology changed oil or if you think about how iPhone or Amazon (AMZN) has changed the inflationary impulse and consumption. I think long-term inflation stays lower than it has historically--and demographics is a big part of that.

However, I also think, in the near term, you could see some inflation. People have thought that inflation is dead for a long time. We've been adding a bit in terms of inflation protection, in TIPS. We use the inflation component within TIPS. We've been adding some of that recently. We've actually been adding it in Europe as well--so-called "linker bonds." So, longer term, we are not that concerned about inflation really accelerating. In the short term, though, we're adding a little bit of protection because I think, in the near term, while we think inflation will pick up a bit and people will say that we are coming closer to the Fed's and the ECB's targets, you are not paying much for that protection today.

So, we think, in particular, in the longer-dated TIPS--10-year, 30-year--that you are getting paid for taking that on, despite the fact that we don't think we'll be going through another cycle of significantly higher inflation for a while.

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