BlackRock Commentary: Positioning for the new nominal

Jean Boivin, Head of the BlackRock Investment Institute together with Mike Pyle, Global Chief Investment Strategist, Vivek Paul, Senior Portfolio Strategist, and Natalie Gill, Portfolio Strategist all part of the BlackRock Investment Institute, share their insights on global economy, markets and geopolitics. Their views are theirs alone and are not intended to be construed as investment advice.

A key consequence of this year’s policy revolution is the potential for a more muted response of nominal yields to higher inflation, in our view. This means investors should start positioning their long-term portfolios for this new dynamic now, in our view. We favor holding more inflation linked bonds and see equities supported by falling real rates in strategic portfolios.

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This information is not intended as a recommendation to invest in any particular asset class or strategy or as a promise – or even estimate – of future performance. Source: BlackRock Investment Institute, with data from Refinitiv Datastream, December 2020. Notes: The chart shows the implied equity risk premium and the sensitivity of 5-year expected returns to a 50 basis point rise in  nominal rates for MSCI USA sectors. Past performance is no guarantee of current or future results.  Indexes are unmanaged and do not account for fees.  It is not possible to invest directly in an index.


The joint fiscal and monetary policy revolution this year implies central banks will likely keep nominal bond yields capped – even as inflation rises. We believe this has big implications for overall asset class returns – and sector performance. The sensitivity of different equity market sectors to rising interest rates varies. Traditional “value” sectors with higher equity risk premia, such as energy, typically have outperformed others in periods of rising nominal rates. The chart above shows our estimate of the expected return impact on each sector from a hypothetical 0.5% rise in U.S. nominal rates: financials and energy would suffer least and technology the most. Higher-valued growth sectors with lower equity risk premia – such as tech – have higher sensitivity to interest rates due to their long-duration cash flows. Yet rangebound nominal rates and lower real rates – as in our base case – mean we are unlikely to see a clear catalyst for a durable rotation to value from growth as past periods with rising inflation would suggest.

The changing relationship between inflation and interest rates is a key investment theme that we name The new nominal, as detailed in our 2021 global outlook. Our inflation outlook is structural in nature. It is due to the impact of the joint fiscal-monetary policy revolution and higher production costs from the expected realignment of global supply chains, rather than simply a large, external supply shock that has historically been a driver of inflationary pressures.

We do not see inflation expectations becoming unanchored as they did in the 1970s, and instead expect U.S. consumer price index (CPI) inflation to average just under 3% between 2025-2030. Yet investors may be under-appreciating the potential for higher inflation, in our view. Breakeven inflation rates – a market-based measure of inflation expectations – have risen since March, but are still materially below our expectations. Even the modest rise in price pressures we anticipate would be a significant departure from the experience of recent decades, during which inflation has persistently undershot central bank targets. This large gap between our expectation and market pricing may offer a strategic investment opportunity. Investors could start positioning their strategic portfolios to guard against risks – and take advantage of opportunities – presented by the new nominal.

In our new inflation playbook, nominal yields will be less responsive to rising inflation. Combined with the fact they are closer to effective lower bounds, we believe this likely means a narrower expected range for yields. As a result we see less negative correlations with risk assets and a challenge to the role of nominal government bonds as portfolio ballast. Falling real yields alongside higher inflation increases the expected returns of inflation-linked bonds relative to nominal government bonds, underscoring our preference to reduce nominal bond holdings and add inflation-linked exposures.

The bottom line: A new inflation regime has major implications for strategic asset allocation decisions, in our view, with a material cost to both getting the inflation call wrong and misinterpreting the impact of inflation on nominal and real yields. In our base case we prefer holding more inflation-linked bonds and less nominal government bonds. Limits on nominal bond yields mean our preferred equity allocation stays higher than it would typically in an inflationary environment.


Market Updates

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Past performance is not a reliable indicator of current or future results. Indexes are unmanaged It is not possible to  invest directly in an index. Sources: BlackRock Investment Institute, with data from Refinitiv Datastream, December 2020. Notes: The two ends of the bars show the lowest and highest returns at any point this year to date, and the dots represent current year-to-date returns. Emerging market (EM), high yield and global corporate investment grade (IG) returns are denominated in U.S. dollars, and the rest in local currencies. Indexes or prices used are: spot gold, Datastream 10-year benchmark government bond (U.S. , German and Italy), MSCI USA Index, Bank of America Merrill Lynch Global Broad Corporate Index, MSCI Emerging Markets Index, J.P. Morgan EMBI index, Bank of America Merrill Lynch Global High Yield Index, the ICE U.S. Dollar Index (DXY), MSCI Europe Index and spot Brent crude.

Market backdrop

Global stocks hit record highs as the UK started its vaccination campaign, while U.S. fiscal package talks continued. Positive vaccine news has been a game changer for markets. We now know we are building a bridge to somewhere, providing clarity for policymakers, households and companies about getting to a post-Covid stage. Yet disappointing jobs data in recent weeks pointed to near-term risks as the virus surges around the U.S., potentially slowing the restart.

Week Ahead

  • December 15: U.S. industrial production
  • December 16: The Fed’s policy meeting; flash composite PMI for Japan, the U.S. and euro area
  • December 17: Bank of England rate decision; U.S. Philly Fed business index
  • December 18: Bank of Japan rate decision

Monetary policy meetings of a few major central banks are the focus this week – against the background of stalling activity restart as restriction have tightened with worsening virus spread. The Fed could update guidance on its asset purchase program – such as committing to buying assets until it sees macro conditions improve – even though it is not expected to change its guidance on policy rates.

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