Debt ceiling: Bond market moves as investors eye negotiations

BlackRock Global Co-Head of Bond ETFs Steve Laipply sits down with Yahoo Finance Live to talk about market volatility amid prolonged debt ceiling negotiations and how to better position fixed-income portfolios.

Video Transcript

SEANA SMITH: The uncertainty over the debt ceiling taking a toll on the bond market, short-term yields hitting a 20-year high as we get closer to the so-called ex date of June 1st. Joining us now is Steve Laipply. He's BlackRock global cohead of bond ETFs for this week's ETF report brought to you by Invesco QQQ. Steve, when it comes to the debt ceiling, how investors have been reacting to it, what it means for the bond market going forward, what do you expect in terms of the volatility that we could see take place over the next several trading days?

STEVE LAIPPLY: Well, I think you just said the key point. It's going to be volatility. So far, we've seen investors being somewhat circumspect about it. We've seen some rotations out of the short end of the yield curve towards longer durations. I wouldn't characterize that as is large size yet, but we are starting to see investors becoming increasingly aware and concerned about this.

AKIKO FUJITA: Steve, what do you think it's going to take to create those jitters? We have heard that lawmakers aren't likely to act unless they see huge moves in the market. Yes, we've seen some moves to the downside, but not significantly. The fixed income market certainly very much in focus because of what's playing out in DC, but what do you think could be potential triggers that move things to the downside?

STEVE LAIPPLY: Well, if we go back to 2011, I believe that the situation was resolved about two days before the purported ex date back then. Leading up to that point, I think you did see a fair amount of equity market volatility. So will that happen again, we're not sure. We are seeing the market sell off. We haven't seen any huge drawdowns yet. But you know, obviously, that type of volatility is going to get increasing attention, should it actually transpire.

At this point, we think investors should be defensive in their positioning as we're going into this. We also, by the way, have another Fed meeting coming up. So there is a lot going on in the bond market to focus on. We are seeing investors positioned for that somewhat accordingly, high quality fixed income, longer duration, really trying to put some ballast into the portfolio heading into June because we do have some market events coming up that could be fairly significant in terms of volatility.

SEANA SMITH: You know, Steve, you've said-- you've called it a generational opportunity. More specifically, why do you see that, and where within fixed income are you seeing the most opportunity?

STEVE LAIPPLY: Yeah, we did just put out a piece called the great yield reset about the generational opportunity. And why are we calling that? Well, you have not seen yields at these levels since the end of the financial crisis. So we're going on in well over 10 years of very low yields. In the past year, we've had this reset in yields to a level where investors can now earn more at the front end of the Treasury curve in something like two-year treasuries than they could in high yield two years ago. What does that mean for investors and for portfolios? It means that you can actually hit yield targets now with a lot less risk than you used to have.

And so we believe that it is the time now to re-examine your entire portfolio, understand that you can achieve these yield targets in ways that you couldn't a couple of years ago with more liquidity, less credit risk, et cetera. So it's a great time to look at fixed income. At the moment, because of the uncertainty around the economy and all these events coming up, we do recommend investors stick to high quality and fixed income. So we're seeing flows into treasuries, investment grade credit as an example, and then broad multi-sector investment grade funds as well.

AKIKO FUJITA: Yeah, on that front, Steve, you know, you've said that you think the average portfolio is underallocated to fixed income. Looking at specifically where the money should be in fixed income, what do you think that exposure should look like?

STEVE LAIPPLY: Yeah, I think as we point out, it's time to re-examine the 40% of your 60/40. And again, it's an opportunity to really think about how that 40's positioned. So oftentimes, investors in the past would focus on the equity side and simply say, well, I'll just throw my 40 into a broad exposure. It's a good opportunity to actually look at that more closely. And depending on your goals for fixed income, you have the ability now with this ETF toolkit to tailor that in ways that you couldn't even five years ago. And so what do I mean by that?

So as an example, if you do want more income, you don't simply have to just buy a high-yield fund. You can get a lot of income now in, say, for assets at the front end of the yield curve that, two years ago, you probably would have had to have gone down in credit and take on some more illiquidity to do that. But now you can do that with much higher quality assets.

So, also, I think it's underappreciated at this point, but the idea that fixed income can provide ballast in the portfolio, and by that, I mean diversifying against equities. We believe that is back. And so even adding some duration at this point, once we get through this difficult June period, might make sense. If you do believe that we're heading into a slowdown, it might make sense to start adding back some duration to the portfolio as an offset to your riskier assets such as equities.

SEANA SMITH: Steve Laipply, BlackRock global co-head of bond ETFs, thanks so much.