BlackRock Commentary: Inflation – beyond near-term volatility

Jean Boivin, Head of the BlackRock Investment Institute together with Elga Bartsch, Head of Macro Research, Wei Li, Global Chief Investment Strategist, and Vivek Paul, Senior 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.


Inflation looks set to overshoot the Fed’s target as we have expected. Yet we see uncertainties around the near-term persistence of the overshoot as the restart leads to unusual supply and demand dynamics. We have closed our tactical overweight in inflation-linked bonds as inflation expectations have risen sharply, but favor them strategically as we see medium-term inflation still underpriced.

Article Image 1 Inflation beyond near-term volatility 03-05

Forward looking estimates may not come to pass. Sources: BlackRock Investment Institute, U.S. National Federation of Independent Business, Bureau of Labor Statistics, Reuters News, with data from Haver Analytics, April 2021. Notes: The orange line shows the net balance of firms in the NFIB survey of small and medium-sized businesses reporting that they are currently raising their prices. A value of 0 indicates that the number of firms raising and reducing their prices is the same. The solid yellow line shows the annual change in the U.S. core CPI inflation rate. The dotted line indicates estimates for core CPI. Expected values for 2021-22 are based on the Reuters consensus as of March 2021. The core CPI estimates from 2022 onwards are based on our expectations of the likely path of GDP growth, spare capacity in the economy and the outlook for monetary policy.

 

The Covid shock is more akin to a natural disaster followed by a rapid “restart” – rather than a traditional business cycle recession followed by a “recovery”, in our view. We see this distinct nature of the shock as having profound implications for inflation: The pandemic didn’t cause a shortfall in demand as in typical recessions; it has instead led to shortfalls in both supply and demand. As the economy restarts, both supply bottlenecks and pent-up demand are coming into sharp focus. Small U.S. businesses slashed prices at the onset of the pandemic, coinciding with a dip in the core consumer price index (CPI), or prices excluding those of volatile energy and food. See the chart above. The trend has since turned, with many small businesses raising prices. Consensus forecasts point to a peak of inflation in May, yet we believe inflation could be volatile in the near term and see risks to the upside given the unusual interplay between supply bottlenecks and pent-up demand as the restart plays out.

Right now we are witnessing supply constraints being pitted against surging demand as the economy reopens. Global supply chains have come under pressure during the pandemic, as companies are faced with challenges including component shortages, rising raw material prices and longer delivery times. Meanwhile we expect the pent-up demand to unleash as virus restrictions ease and activity reopens. This unusual dynamic could lead to volatile inflation in the near term, in our view. In addition, it could allow many companies more power to pass on higher input prices to consumers with cash to spare, preventing compression in profit margins.

We have closed our tactical overweight in Treasury Inflation-Protected Securities (TIPS) after sharp increases in both inflation expectations and nominal bond yields. The 10-year breakeven inflation rate – a market-based measure of inflation expectations – has risen from 0.5% last March to about 2.4%. It has also become less responsive to recent inflation data surprises. We don’t see it moving significantly above 2.5% in coming months. Net inflows to TIPS exchanged-traded products (ETPs), on a rolling six-month basis, have hovered near record levels hit last December, according to Bloomberg.

We see U.S.CPI inflation averaging just under 3% between 2025-2030, and we believe this is still underpriced by markets. First, we expect higher production costs as the pandemic accelerates the rewiring of global supply chains. Second, major central banks are evolving their policy frameworks and explicitly intend to let inflation overshoot their targets. Third, the higher debt levels will make it harder for central banks to lean against inflation – and make the decision to start tightening more politicized, in our view. When looking at the concrete impact of higher debt servicing costs due to tightening monetary policy, the less tangible – but no less real – risk of loosening the grip on inflation expectations will likely pale in comparison.

The bottom line: We will likely see peak growth data and volatile inflation data in coming months – different from typical business cycle recoveries where better growth data typically have led to higher inflation. This may trigger some knee-jerk reactions and market volatility. We believe markets are still underestimating the potential for above-target inflation over the medium term. As a result we prefer inflation-linked bonds and are underweight nominal government bonds over the strategic horizon.

Market Updates

Article Image 2 Inflation beyond near-term volatility 03-05

Past performance is not a reliable indicator of current or future results. Indexes are unmanaged and do not account for fees. It is not possible to invest directly in an index. Sources: BlackRock Investment Institute, with data from Refinitiv Datastream as of April 29, 2021. 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, in descending order: spot Brent crude, MSCI USA Index, MSCI Europe Index, MSCI Emerging Markets Index, Bank of America Merrill Lynch Global High Yield Index, ICE U.S. Dollar Index (DXY), Refinitiv Datastream Italy 10-year benchmark government bond index, Bank of America Merrill Lynch Global Broad Corporate Index, J.P. Morgan EMBI index, Refinitiv Datastream Germany 10-year benchmark government bond index, Refinitiv Datastream U.S. 10-year benchmark government bond index and spot gold.

Market backdrop

A decline in U.S. Treasury yields and strong corporate earnings are providing some support to equities. The S&P 500 Index hit a record high last week and posted gains for the third straight month. Among the just over 40% of S&P 500 companies that have reported first-quarter earnings, 85% have beaten estimates, Refinitiv data showed. Mega-cap tech companies reported strong results. President Joe Biden outlined his $4 trillion spending plan to enhance infrastructure and social services, and the Fed reinforced its emphasis on policy patience.

Week Ahead

  • May 3 – U.S., euro zone manufacturing purchasing managers’ index (PMI)
  • May 5 – U.S. ISM non-manufacturing PMI; euro zone composite PMI
  • May 6 – Bank of England policy meeting
  • May 7 – Caixin China services PMI; U.S. nonfarm payrolls

U.S. nonfarm payrolls data will be in focus. Economists expect an increase of 978,000 jobs in April, after a rise of 916,000 jobs in the previous month, according to Reuters. Investors will look for clues on the rebound of sectors that have been most affected by the pandemic as well as a further increase in construction jobs. They will also try to gauge the pace of the economic restart from PMI data from key economies.


BlackRock’s Key risks & Disclaimers:

This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of May 3rd, 2021 and may change. The information and opinions are derived from proprietary and non-proprietary sources deemed by BlackRock to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by BlackRock, its officers, employees or agents. This material may contain ’forward looking’ information that is not purely historical in nature. Such information may include, among other things, projections and forecasts. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this material is at the sole discretion of the reader.

The information provided here is neither tax nor legal advice. Investors should speak to their tax professional for specific information regarding their tax situation. Investment involves risk including possible loss of principal. International investing involves risks, including risks related to foreign currency, limited liquidity, less government regulation, and the possibility of substantial volatility due to adverse political, economic or other developments. These risks are often heightened for investments in emerging/developing markets or smaller capital markets. 

Issued by BlackRock Investment Management (UK) Limited, authorized and regulated by the Financial Conduct Authority. Registered office: 12 Throgmorton Avenue, London, EC2N 2DL.


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Notes from the Trading Desk – Franklin Templeton

Franklin Templeton’s Notes from the Trading Desk offers a weekly overview of what their professional traders and analysts are watching in the markets. The European desk is manned by eight professionals based in Edinburgh, Scotland, with an average of 15 years of experience whose job it is to monitor the markets around the world. Their views are theirs alone and are not intended to be construed as investment advice.

The Digest

Global equities traded marginally lower last week, with much of the focus at a company level as first quarter (Q1) earnings season progresses. The MSCI World Index closed the week down 0.2%, while the STOXX EUROPE 600 Index was down 0.4%, the S&P 500 Index was flat, whilst the MSCI Asia Pacific Index was down 0.9%. Despite strong earnings and record beats, there was lacklustre price action, with significant divergence in each region.

Inflation is showing signs of picking up in Europe, with the German Harmonised Index of Consumer Prices (HCPI) above the European Central Bank’s (ECB) target level. The latest Federal Open Market Committee (FOMC) meeting was largely uneventful. On global fund flows, cash was king last week amid large inflows.

In terms of European earnings, 45% of the STOXX EUROPE 600 Index constituents have now reported Q1 earnings. This has been the second-best season since 2005 in terms of exceeding earnings per share (EPS) estimates, with 74% beating expectations. Q1 EPS growth is coming in at +41% year-on-year (y/y), surprising positive. Revenue growth is up 3% y/y, with seven out of 10 sectors reporting positive sales growth. On the top line, 66% of companies are beating sales estimates. Despite that, from an equity market perspective, Q1 misses have been punished more than beats have been rewarded.

Overall, banks have been the winning sector, but still trading below pre-pandemic levels. Utilities have been the losing sector so far through earnings season—the only sector in Europe to trade lower year-to-date. In Europe, this week again holds a heavy calendar for corporate earnings, with 115 companies (19.1%) of the STOXX EUROPE 600 Index due to report earnings and sales.

In the United States, 208 companies of the S&P 500 Index have now reported earnings, with 83% exceeding earnings estimates, a record high. The largest companies in the S&P 500 Index have beaten earnings expectations by 21.9% but have missed sales expectations by 1.0%. Overall, companies handily beating EPS margins have not necessarily seen better share-price performance though.

Week in Review

Europe

European equities were mixed last week with corporate earnings driving big sector divergence. The STOXX EUROPE 600 Index closed the week down 0.4%. Market volatility rose again, with the European Volatility Index (V2X) up 13% in Europe, with a few different factors providing the push and pull. Corporate earnings have certainly been a driver, but over the last couple of weeks some observers have been questioning whether we will see a sensible selloff in certain areas of the market as valuations remain stretched and equities trade around all-time highs; sentiment appears to suggest that investors are expecting a pullback.

The reopening trade was back on, as governments around Europe provided a bit more clarity on ending lockdowns and as economic data has improved in the region. Goldman Sachs’ reopening basket closed the week up 2.5%, whilst the Stay-at-Home basket was down 0.3%. In terms of country indices, Spain’s IBEX 35 Index was the clear outperformer last week in the region, up 2.3%, helped by strength in the banks and travel and leisure, up 6% and 2.7% respectively.

Sector divergence has been a theme in April, with a near-12% spread between the best and worst performers in the region (retail up 6.7%, automobiles down 4.7%). That theme was evident again last week, with a remarkable 9% spread in sector performance as banks were up 6% on the week, and automobiles were down 2.9%. The automobile selloff last week felt like rotation. US car manufacturer Ford fell as much as 10% on 29 April after reporting earnings; the company offered a bleak view for the year, which didn’t help its European peers. Semiconductor chip shortages also remain a headwind for the sector.

Meanwhile, the travel and leisure sector in Europe was up 2.7%, helped by a report from the European Commission stating the European Union (EU) will let vaccinated Americans visit this summer. Growth stocks have been better off through April, but there was solid outperformance for European value stocks last week versus momentum.

United States

Corporate earnings likewise dominated US equity markets. Sector divergence was significant stateside, with a 5.7% spread between the top performer (energy, up 3.6% last week) and the underperformer (technology, down 2.1%). In amongst all the noise, there was a new all-time high for the S&P 500 Index last Thursday as strong economic data and better-than-expected earnings breathed fresh life into the reflation trade. The index pared those gains last Friday to finish near flat on the week.

Reopening headlines were also supportive, with New York City Mayor Bill de Blasio announcing plans to fully reopen the city on 1 July, though Governor Andrew Cuomo pushed back, staying that he would like it to happen even sooner. Chicago Mayor Lori Lightfoot also announced an easing of restrictions to allow for more seating capacity at restaurants, bars and other indoor venues. Also, last week, the White House released its ‘American Families Plan’, worth US$1.8 trillion, which would be funded by tax increases over the next 15 years for wealthy Americans—all in line with US President Joe Biden’s campaign pledges.

Last week’s FOMC meeting saw little movement from the central bank, which kept rates on hold whilst strengthening its outlook. Federal Reserve (Fed) Chair Jerome Powell said that ‘it’s not time yet’ to talk about tapering as the recovery ‘remains uneven and far from complete’. Nonetheless, on Friday, Robert Kaplan of the Dallas Fed (non-voter) did suggest he would support tapering as he was ‘observing excesses and imbalances in financial markets’, making it ‘appropriate to start talking about adjusting those purchases’. So, it feels like we could see a little more push and pull on that point going forward.

Asia Pacific (APAC)

Asian equities finished lower across the board last week last week, with the MSCI Asia Pacific Index closing down 0.9%. Volumes were lower ahead of the China Golden Week holidays, which started this past weekend. Sector divergence was notable in Asia too, with energy the outperformer, up 2.7%, whilst health care stocks were down 2.5%.

Focus in the region remains on the devastating escalation in COVID-19 cases in India, as new daily cases near 400,000. The health care system remains at breaking point, with many countries providing aid to assist India in desperately fighting the surge in cases and deaths. German biotechnology company BioNTech said its vaccine is effective against the Indian variant. Elsewhere, new coronavirus cases hit a 3-month high in Japan ahead of holidays this week. There was a rise in cases in South Korea, with untraceable infections at their highest point ever. There are signs of stabilisation in cases in Thailand, as the country entered strict lockdown.

Last week, China announced that steel export tax rebates would be cancelled for 146 steel products from 1 May. The removal of the 13% value-added-tax (VAT) rebate is positive news for producers outside of China, as exporting becomes less profitable for China.

Chinese Purchasing Managers’ Index (PMI) data was mixed on Friday. The Caixin/Markit China PMI rose to 51.9 in April, bouncing back from an 11-month low in March, but still well below levels recorded for much of last year. Separate China PMI data, which examines larger, state-owned companies and was also released on Friday, showed a slower-than-expected expansion of 51.1.

Week Ahead

Holidays          

Monday 3 May:  UK, China, Japan, Thailand, Greece, Ireland, Poland, Romania, Russia

Tuesday 4 May:  China, Japan, Greece

Wednesday 5 May: China, Japan, South Korea, Thailand

Macro Week Ahead Highlights

Monetary policy decisions look likely to dominate the week ahead. Central banks in the United Kingdom, Norway and Turkey are all likely to keep interest rates on hold to help their economies recover from the ravages of COVID-19. Industrial production (IP) figures for March from Germany and France will probably show greater resilience as supply constraints ease. The April US employment report (including nonfarm payrolls) comes out on Friday and will be closely watched as usual.

Key Events

Thursday: Norway central bank meeting; Bank of England (BoE) meeting

Friday: Germany IP (month-on-month); France IP (month-on-month)

Monday 3 May

  • Germany: March retail sales
  • Global: April manufacturing PMI
  • US: April ISM manufacturing, April wards vehicles

Tuesday 4 May

  • China: April Caixin manufacturing PMI
  • UK: March mortgage applications, March M4 money supply
  • US: March trade balance, March factory orders
  • South Korea: April Consumer Prices Index (CPI)
  • Reserve Bank of Australia (RBA) interest-rate announcement
  • ECB’s François Villeroy speaks

Wednesday 5 May

  • Global: April services and composite PMI
  • US: April ADP employment, April Institute for Supply Management (ISM) non-manufacturing
  • Fed’s Charles Evans and Loretta Mester speak

Thursday 6 May

  • China: April Caixin services and composite PMI
  • Germany: March factory orders
  • US: May 1 initial jobless claims
  • Japan: April vehicle sales
  • BoE interest-rate announcement
  • ECB publishes economic bulletin
  • Norges bank interest-rate announcement
  • Bank of Japan March meeting minutes
  • ECB’s Isabel Schnabel speaks
  • Fed’s Robert Kaplan and Loretta Mester speak
  • Norges bank Governor Oystein Olsen speaks

Friday 7 May

  • US: April employment report
  • Germany: March IP, March trade balance
  • France: March IP
  • Italy: March retail sales
  • Japan: April monetary base
  • China: April Caixin services & composite, April trade balance,  April foreign reserves
  • ECB’s Christine Lagarde speaks

 


Franklin Templeton Key risks & Disclaimers:

What Are the Risks?

All investments involve risk, including possible loss of principal. The value of investments can go down as well as up, and investors may not get back the full amount invested. Stock prices fluctuate, sometimes rapidly and dramatically, due to factors affecting individual companies, particular industries or sectors, or general market conditions. Bond prices generally move in the opposite direction of interest rates. Thus, as prices of bonds in an investment portfolio adjust to a rise in interest rates, the value of the portfolio may decline. Investments in foreign securities involve special risks including currency fluctuations, economic instability and political developments. Investments in developing markets involve heightened risks related to the same factors, in addition to those associated with their relatively small size and lesser liquidity. Past performance is not an indicator or guarantee of future performance.

This article reflects the analysis and opinions of Franklin Templeton’s European Trading Desk as of 26th April 2021, and may vary from the analysis and opinions of other investment teams, platforms, portfolio managers or strategies at Franklin Templeton. Because market and economic conditions are often subject to rapid change, the analysis and opinions provided may change without notice. An assessment of a particular country, market, region, security, investment or strategy is not intended as an investment recommendation, nor does it constitute investment advice. Statements of fact are from sources considered reliable, but no representation or warranty is made as to their completeness or accuracy. This article does not provide a complete analysis of every material fact regarding any country, region, market, industry or security. Nothing in this document may be relied upon as investment advice or an investment recommendation. The companies named herein are used solely for illustrative purposes; any investment may or may not be currently held by any portfolio advised by Franklin Templeton. Data from third-party sources may have been used in the preparation of this material and Franklin Templeton (“FT”) has not independently verified, validated or audited such data. FT accepts no liability whatsoever for any loss arising from use of this information and reliance upon the comments, opinions and analyses in the material is at the sole discretion of the user. Products, services and information may not be available in all jurisdictions and are offered by FT affiliates and/or their distributors as local laws and regulations permit. Please consult your own professional adviser for further information on availability of products and services in your jurisdiction. 

Issued by Franklin Templeton Investment Management Limited (FTIML) Registered office: Cannon Place, 78 Cannon Street, London EC4N 6HL. FTIML is authorised and regulated by the Financial Conduct Authority.


MeDirect Disclaimers:

This information has been accurately reproduced, as received from Franklin Templeton Investment Management Limited (FTIML). No information has been omitted which would render the reproduced information inaccurate or misleading. This information is being distributed by MeDirect Bank (Malta) plc to its customers. The information contained in this document is for general information purposes only and is not intended to provide legal or other professional advice nor does it commit MeDirect Bank (Malta) plc to any obligation whatsoever. The information available in this document is not intended to be a suggestion, recommendation or solicitation to buy, hold or sell, any securities and is not guaranteed as to accuracy or completeness.

The financial instruments discussed in the document may not be suitable for all investors and investors must make their own informed decisions and seek their own advice regarding the appropriateness of investing in financial instruments or implementing strategies discussed herein.

If you invest in this product you may lose some or all of the money you invest. The value of your investment may go down as well as up. A commission or sales fee may be charged at the time of the initial purchase for an investment. Any income you get from this investment may go down as well as up. This product may be affected by changes in currency exchange rate movements thereby affecting your investment return therefrom. The performance figures quoted refer to the past and past performance is not a guarantee of future performance or a reliable guide to future performance. Any decision to invest in a mutual fund should always be based upon the details contained in the Prospectus and Key Investor Information Document (KIID), which may be obtained from MeDirect Bank (Malta) plc.

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