Photographs by Natalie Brasington Photography
BlackRock's Global Head of Fixed Income, Peter Fisher, understands bond markets and what moves them. Fisher began his career in 1985 at the New York Federal Reserve Bank and spent most of his time running the open market operations. He basically served as the Fed's asset manager, implementing Chairman Alan Greenspan's and the Federal Open Markets Committee's policies.
He went on to serve as an Under Secretary for Domestic Finance at the Treasury Department before taking his skill to the behemoth asset manager BlackRock. Fisher led BlackRock's Asian operation before moving to the fixed income division and eventually running it. We spoke to Fisher about the Eurozone debt crisis, its impact on the United States and what comes next for Treasuries.
Futures Magazine: Peter, how did you move from the Federal Reserve to Treasury to running BlackRock's fixed income portfolio?
Peter Fisher: I was in the asset management/risk management business for the Fed and the Treasury, and [it] was a pretty easy jump to a firm focusing on asset management and risk management.
FM: Give us an assessment of the Eurozone sovereign debt crisis. What will be the long-term impact of the liquidity injections on Nov. 30?
PF: What we should recognize while we are watching the drama unfold in Europe [is that] we are seeing the consequences of the policy mistake they made two years ago, tightening monetary and fiscal policy too quickly in the face of ongoing global deleveraging. The world financial system need to delever after the crisis in 2008 and Europe thought they could tighten fiscal and monetary policy and be unaffected by that. That is what triggered the chaos in European sovereign bond markets, and their financial sector really couldn't take that strain. Now we are seeing whether they could pull out of making that fundamental error of tightening too quickly. The liquidity injections at the end of November were a bridging operation with the central banks around the world trying to show support for Europe and whether Europe could come together with more fundamental policy initiatives. We still are waiting to see whether those will bear fruit.
FM: Was it the wrong time to be austere?
PF: It is a challenge for fiscal policy to tighten in the face of economies that are this weak. That is the dilemma Europe has been facing and, frankly, we are facing here in the United States. What is desirable is if the politicians could just figure out how to act now to cut our long-term liabilities and not cut spending too much in the next year or so. They could get the time path right in a way that wouldn't hurt the economy now but could give confidence to credit markets and fixed income markets around the world. They are struggling to find a way to do it. You can see in the Italian government's efforts in their austerity budget, it is to change some of those long-term pension and health care liabilities to bring them down into line with the rate of revenue growth. The worry is [that] they tighten things too quickly in the short run. We have the same issues.
FM: We keep hearing that Europe is throwing good money after bad and eventually must bite the bullet and let the debt of these peripheral countries fail. Do you agree?
PF: Whether or not the peripheral sovereign countries in Europe need to restructure their debt is really up to how the countries want to choose to deal with the whole area. It is not necessary that all the countries restructure. Greece is probably an outlier. It will have a hard time meeting its debt obligations going forward. I don't know that the other countries have to restructure their debt. [There is risk] of [throwing] good money after bad in terms of just buying the debt while they tighten fiscal and monetary policy. That was not working. It is giving with one hand and taking away with the other. We have seen the ECB start to ease rates again, we've seen them do some bond buying, they're clearly trying to get a quid pro quo with the sovereigns cutting back on fiscal spending in order for them to feel comfortable doing any more bond buying. That might get you to a place where it is not throwing good money after bad. But clearly they both have to stabilize their banking system and they have got to come up with a pro-growth policy. These countries are going to have a very hard time stabilizing their revenues and their fiscal outlook if they now slip into recession. They have got to do something on the pro-growth side as well as something on the stability side.
FM: What would be the fallout if some European countries default?
PF: A lot of this is already priced into the market. These are small peripheral countries. They have had an outsized impact on confidence and you can see [it] wearing on the markets for the last year or so. But investors and markets are trading [this debt] at very low prices so markets already have reflected that. The principal impact it would have from a restructuring or default is the probability [that] it signals other defaults coming. That is why the authorities are so interested in their firepower. Can they ring fence the countries they don't want to have under threat? If there are further restructurings and downgrades, we'll be looking to see what we think the consequences of that are on confidence and the probability that other countries will follow.
FM: What would be the fallout in the United States?
PF: It is how it would affect balance sheets in the U.S.: Bank balance sheets, investor balance sheets, insurance company balance sheets. A single restructuring by Greece might not have that profound an effect, but on confidence what it would do with the rest of the bonds we are all holding, that is the principal worry that we have. I don't think it needs to have a profound effect if the authorities have done the right things but if it looks like the political agreements don't come together then there will be a bigger impact, and weigh on the assets we are holding and run the risk of a further spiral.
FM: We are hearing a lot of talk about another potential downgrade of U.S. debt. First off, do you expect it to happen and second what would be the impact?
PF: I can imagine the ratings agencies downgrading the U.S. again or for the first time in the case of two of the agencies. That is a reasonable thing for them to do, but the US is one of the better [credit risks] in the world. I don't doubt that we've got a more resilient economy, that we've got a smaller black [market] economy, more tax collection power than any other economy in the world. I don't think of the U.S. as downgraded in the sense of its ability and willingness to pay, which is what the ratings agencies should be focusing on. Now if I were running a ratings agency I might have downgraded the U.S. in 2003 when Congress enacted the Medicare drug benefits; I might have been tempted to downgrade the U.S when the Bush tax cuts were extended at the end of 2010. Those are event that had a material impact on outlays and revenues. I am less impressed when the ratings agencies downgraded the U.S. on the sort of short-run political calculus going on [in] Washington. We saw in August with the downgrade that did happen that it led to a rally in Treasuries. That demonstrated that Treasuries were still — notwithstanding the downgrade — the best credit in the world. And in a world in which risks are going up, people buy more of the lowest risk asset, which turned out to be Treasuries. That irony played out in August. Now with another downgrade that might not happen. We might not see that rush into Treasuries as a consequence of the downgrade. It depends on the circumstances in which it happens and whether the economy looks like it is weakening or strengthening. Many people overplay the influence of ratings agencies on sovereigns when the path of real growth and the path of central bank behavior probably have a bigger impact. I am not quite sure what another single downgrade would be. It depends on whether it comes from S&P or one of the other agencies. Finally, the downgrade that happened took the Treasuries from the very very best rating to a very very good rating and if you look at how things are trading in the CDS market, even after the downgrade, Treasuries traded with narrower spreads than some other sovereigns that hung onto their AAA rating.
FM: Traditionally sovereign debt — whether U.S. or non-U.S. — has been the most solid, most conservative part of a portfolio. What has been the impact of the loss of confidence of sovereign debt?
PF: There are two questions to take up there. One is looking at the peripheral debt or the very weak sovereigns. There, the bonds have gone from being treated as a de facto risk-free asset — the preferred asset of the banking system — and fallen all the way [down] to being an impaired credit asset, so that is a very big jump. The jump to weak credit status from being treated as a slightly higher spread version to German government securities has had a profound effect on big portfolios, many of whom simply stopped holding them entirely. Not so much because they consciously thought there was a risk of default but mostly because they just don't hold bonds for the purpose of this much volatility. Now more fundamentally, people talk about the role of the risk-free asset and is it really a risk-free asset? Treasuries, bonds have never been risk free; they have had a lot of duration risk in them. What we are really looking at when we look at what we call a risk-free rate, we are looking at the best expression of the time value of money that we can find. We are using the sovereign curve — the Treasury curve, the bund curve, the gilt curve — as a way of measuring the time value of money. The question is, are we going to come up with anything else? We though for some time over the last 15 years or so that maybe the interest rate swap curve could be a substitute for sovereigns. But the more we look a financial sector that trades them; the counterparty risk imbedded in trading interest rate swaps looms a little large.
If the world is a riskier place than you thought, then you hold more of the lower risk asset, which turned out was Treasuries. Clearly the low level of yields we are looking at is a form of risk aversion. Just like the low P/Es we [see] in the equity markets, the high bond prices/low yields reflect a lot of investors' anxiety about the world and they want to hold — even if it is a lower yielding-asset — a lower-risk asset.
FM: What is your opinion of credit default swaps (CDS's)? Are they useful tools or something very dangerous? Should additional restrictions be put on them?
PF: Clearly CDS's are both useful and dangerous. The dangerous part is where we don't get enough bilateral margining. One of the behaviors that built up several years ago was no two-way margining, which has been a mistake. Frankly, the futures industry got this right a long time ago with more disciplined bilateral margining and margining against the clearinghouses and the over-the-counter (OTC) market — while I have always been a fan — I always thought we should have much more disciplined two-way margining. If you get that then you'll hold down the level of leverage implicit in the CDS market and drive to much better behavior.
FM: What is your opinion on the Dodd-Frank directive to clear over-the-counter interest rate products?
PF: We've been supportive of the Dodd-Frank reforms to get more [OTC] products into clearinghouses, moving interest rate products and CDS into the new structure. The industry is going to have to adjust to the OTC account class. These are much longer-term instruments than the futures industry normally has. Interest rate swaps last for years and years and years, not just three months. Putting clients' money at risk and collateralizing these obligations is something that is going to take a lot more thinking, and we have been talking to the industry and the CFTC to make sure that the clients' interest in ensuring that their collateral is theirs and not someone else's is well protected.
FM: According to your web site BlackRock has $3.345 trillion under management. How much of that is in your traditional bond portfolios? To what extent has BlackRock expanded to a full service provider?
PF: We've got $3.3ish trillion under management at BlackRock, about a third of that, $1.1 trillion, is in fixed income broadly defined. We have about $600 billion in traditional bond portfolios and about $450 billion in index and iShares portfolios and other client funds in alternative products. One area we have been developing is alternative products in the retail space; in fixed income we have brought a global long-short credit product to market for qualified retail investors. We think this is a very useful product given the low yield environment. By taking both long and short views in credit space we can generate higher returns for investors and do it in a prudent way.
FM: Is it fair to say BlackRock is no longer just a bond house?
PF: Certainly not BlackRock. Not with our broad array of fixed income and equity and alternative products. We are offering the full range of products and we are one of the biggest alternative houses on the planet.
FM: Earlier this year the Fed indicated it would keep the Fed Funds rate frozen through mid-2013. What impact did that have on the bond market? Is this a good policy?
PF: It was good policy in a couple of senses. First, we see the mistake in Europe of tightening monetary and fiscal policy prematurely. Our financial sectors are very fragile. We still see delevering, we see financial sector delevering, we see household delevering. You tighten prematurely into that and you see what you get in Europe today. The Fed has been anxious to make sure people don't expect rates to back up prematurely. They also realized the economy was much much weaker than they had hoped. In that environment, one of the most powerful ways they can stimulate the economy is by persuading us that the expected path of short-term rates will be low for a long time. It really had a dramatic impact on interest rate markets and capital markets in general. It was the best tool that they had at their disposal to respond to the weakness in the economy. The point about the delevering financial sector should be underscored; these are not first best choices. These are difficult trade-offs the Fed is making. It is not without costs of having rates this low; and what it is doing to the income of savers and what it is doing in capital markets with these very low yields. But given the alternative it was a very wise move on the Fed's part.
FM: Many analysts feel that the extraordinary monetary accommodations of the last several years is setting the U.S. up for massive inflation. Do you agree?
PF: It is certainly a risk but it is a risk the Fed is running reasonably. I have been telling clients for some time that inflation is coming later than you think. Given how median income in the United States has been falling for three years, given the weakness in the economy here and the European economy, you can see a slowdown happening now in China and East Asia; it doesn't seem to me that inflation is the risk right under our noses for the coming year. It is something that you can worry about further out. Two things have to happen for inflation to really become a problem that would upset investors. The first is that the economy would have to pick up a lot of speed. It is very hard for me to see inflation really getting in the area that would be concerning without the economy getting much stronger and then the Fed would have to not tighten policy in time. Those two things could happen but it would be a pretty good outcome to see the economy pick up speed and then the central banks and the Fed in particular. Given the errors we lived through in the late 1970s, the Fed would likely tighten in a timely manner. It is clearly a risk but I don't think [higher inflation] is the central expectation that I have for the coming year but we will have to see. If the economy does do better, I can see inflation being a problem a little further out.
FM: But we have seen price inflation. Is there some way for investors to prepare?
PF: Obviously there are inflation-linked securities; TIPs (Treasury Inflation-Protected Securities) here, linkers (Inflation-indexed bonds) around the world, the various commodity plays. Clearly people have made some money in the gold market and other commodity markets over the last couple of years. If you want to look at the TIPs market as a hedge against inflation, investors should be very clear on why they are buying TIPs. You could imagine them being a play on real rates, in which case you hold them hoping real rates go lower and you pick it up on appreciation. If you are buying TIPs as a hedge against inflation, then you should expect real rates to back up before the inflation premium kicks in and you get your inflation insurance. Some people are afraid that TIPs are too expensive now that rates have rallied so far; well they are not going to be expensive if what you are worried about is high inflation in the future. That is the easiest way to hedge yourself but you have to be clear on why you are buying them.
FM: We are in the midst of a 30-year-plus bull market in Treasuries. Will this end any time soon?
PF: We are nearing the end of the rally that can unfold. Some people therefore think the next move is 30 years of interest rates backing up; I don't know that is the most likely outcome. If you look at 100 years of data, interest rates have been pretty low so the question is what are we mean-reverting to? If we are going to mean-revert back up to the high inflation of the late-70s/early-80s, then we are going to have 30 years of backup; if we mean-revert to the last 100 years of data, interest rates are going to stay right around 2 or 3% for a while.
That is the real challenge for investors. The Fed anchoring expectations for rates staying low tells us a fair bit about what is going to happen for the next year or so until the Fed gives us different expectations.
FM: Do you expect a change in either long- or short-term rates in 2012?
PF: Not in short-term rates, the Fed has been pretty clear, unless the economy picks up steam dramatically. Ten-year U.S. rates I can see trading in the low 2% range for most of the year. They might back up if the economy picks up, but the Fed having anchored short rate expectations is going to be a powerful force keeping rates somewhere near the 2-3% range.
FM: What is the best investment in the fixed income arena? The safest?
PF: If you are focused on safety, you are going to look at Treasuries. A very reasonable investment strategy for most investors is to look at some of the more secure spread sectors like municipal securities, like investment grade credit and even like our high-yield market, which is nowhere near as risky as it was in the 1980s. Companies are not as highly geared as they were then. A diversified portfolio of municipal securities, investment grade credit, some high-yield, could be a very sensible portfolio, picking up a little spread in this environment where I don't expect rates to back up very much over the coming year. They may back up a little but if you've bought some of these spread products you are going to have picked up enough income to overcome that.