Day: 18 January 2022

Jean Boivin together with Wei Li, Global Chief Investment Strategist, Alex Brazier, Deputy Head, Elga Bartsch, Head of Macro Research and, Scott Thiel, Chief Fixed Income Strategist all forming 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.

The year is off to a rocky start, with a jump in 10-year Treasury yields and a swoon in tech shares pulling down stocks. The culprit? Markets believe the Fed will raise rates sooner and more aggressively than expected. That’s not the story, in our view. The sum total of expected rate hikes remains low, thanks to a historically muted Fed response to inflation. Instead, the yield spike tells us that investors are less willing to pay a safety premium for bonds – and isn’t bad news for stocks per se. 

Past performance is not a reliable indicator of current or future results. Indexes are unmanaged and not subject to fees. It is not possible to invest directly in an index. Sources: BlackRock Investment Institute, with data  from Refinitiv Datastream, January 2022. Notes: The left chart shows the U.S. 10-year Treasury yield along with New York Federal Reserve estimates of two components of that yield, expected interest rates and the term premium (the premium investors typically demand to hold riskier long-term government bonds). The right chart shows the cumulative breakdown of the change in the 10-year yield since its low point on Dec. 3, 2021.

 

The plunge in global government bond prices at the start of this year underscores the new market regime highlighted in our 2022 Global Outlook. The trigger was the Fed indicating a faster-than-expected policy normalization, including speeding up the timeline for letting its bond portfolio shrink. Markets quickly priced in faster and more rate hikes this year against a backdrop of 40-year high inflation and a tight labor market. Equities have come under pressure as growth stocks lost some of their luster with the apparent prospect of higher interest rates making future earnings less attractive. Is all of this bad for equities? We don’t think so. What really matters for stocks, in our view, is that the Fed has kept signaling a low sum total of rate hikes. That hasn’t changed. Indeed, expectations for the future fed funds rate (the yellow line in the chart) have risen only modestly in the last six weeks, whereas 10-year Treasury yields have shot up (the green line). The driver instead is an increase in the term premium (the red line), the extra compensation investors demand for the risk of holding government bonds at historically low yield levels.

Understanding the drivers behind both the Fed’s muted response and the yield spike are key to navigating this environment. The Fed has adopted new policies that let inflation run a little hot to make up for below-target inflation in the past – and has now met its target. We believe the Fed and other central banks will want to keep living with inflation. Why? Today’s inflation is triggered by pandemic-induced supply constraints, a sea change from decades of demand-driven price pressures. Our upcoming Macro and market perspectives will explain why this matters: Tightening would only serve to hurt growth and employment at a time when the economy has not yet reached full capacity. Central banks are merely lifting their foot from the gas pedal by starting to remove emergency stimulus released when the pandemic hit in 2020, in our view. This muted response should only modestly increase historically low real, or inflation-adjusted, yields and underpin equity valuations.

The recent yield spike ostensibly has echoes of 2013’s “taper tantrum” when the Fed then flagged a reduction of bond purchases. Yet we see key differences: It’s not driven by fears of a sharp increase in the policy rate;  growth is strong; and the Fed has honed its signaling. The Fed’s planned reduction of its balance could result in investors demanding a higher term premium for holding long-term bonds – but this need not be negative for equities in contrast to the taper tantrum, in our view. So far the Fed’s pivot on policy matters less for medium-term investors focused on the cumulative policy response.

We see three main risks. First and foremost: Central banks actually hit the brakes or markets think they might – a bad outcome for both stocks and bonds and one of the alternative scenarios to our base case laid out in our 2022 Global Outlook. We also considered the possibility of a sharper rise in the term premium relative to our base case for a more gradual increase depending on how the Fed handles the shrinking of its balance sheet. Second, we believe the Omicron strain presents downside risks to China’s growth outlook, especially given the influx of visitors for the Winter Olympics. We expect the country to maintain its zero-COVID policy – at least optically – in this politically important year. This heralds more restrictions on activity, even as Beijing appears bent on achieving its growth target this year by loosening policy. Third, we see potential conflict risks surrounding Iran’s nuclear ambitions, Russia’s massing of troops near Ukraine and, to a much lesser extent, Taiwan. These could rattle investors at a time the market’s attention to geopolitics is low. See our geopolitical risk dashboard. Our bottom line: We prefer equities in the inflationary backdrop of the strong restart of economic activity. We favor developed market stocks as we dial down risk slightly and are underweight government bonds.

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 January 14, 2022. Notes: The two ends of the bars show the lowest and highest returns at any point over the last 12-months and the dots represent current 12-month 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, ICE U.S. Dollar Index (DXY), MSCI Emerging Markets Index, Bank of America Merrill Lynch Global High Yield Index, J.P. Morgan EMBI Index, spot gold, Refinitiv Datastream Italy 10-year benchmark government bond index, Bank of America Merrill Lynch Global Broad Corporate Index, Refinitiv Datastream Germany 10-year benchmark government bond index and Refinitiv Datastream U.S. 10-year benchmark government bond index.

 

U.S. CPI hit a 40-year high of 7% with little market reaction. We see the report as more evidence that supply factors are shaping the macro backdrop. The fundamental culprits are the sputtering restart of supply and reallocation of resources spurred by the pandemic. The problem: policymakers can’t stabilize inflation without destroying activity. It’s a key reason why central banks have flagged a muted response to inflation. We see inflation settling at a level higher than pre-COVID.

Week Ahead

• Jan.17  – China urban investment, industrial output, retail sales and Q4 GDP
• Jan. 18 – UK unemployment data Bank of Japan policy decision
• Jan. 19 – UK CPI
• Jan. 20 – U.S. Philly Fed Business Index

The stream of fourth-quarter corporate results picks up pace this week, with a key question whether companies can keep up their profit margins by passing on input price increases. Investors may also get an early read on the impact of Omicron on future results. Some 8% of S&P 500 companies are set to report this week, dominated by financials, healthcare and real estate. UK inflation and employment could guide the Bank of England in the timing and magnitude of further rate rises.

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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 January 18th, 2022 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.

MeDirect Disclaimers:

This information has been accurately reproduced, as received from  BlackRock Investment Management (UK) Limited. 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.

Franklin Templeton’s Notes from the Trading Desk offers a weekly overview of what our 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

On a week where there was little change in broader market themes, we saw some notable moves “under the hood” in equity markets. At a broader index level, market moves were fairly moderate, with the MSCI World Index closing the week down just 0.1%. There was a continuation of themes from the previous week, with the main market driver being the apparent shift in monetary policy sentiment within the central banks. With that, the rotation continued last week as growth stocks sold off and value stocks continued their recovery.

Concerns over the extent of the Federal Reserve’s (Fed’s) upcoming rate tightening cycle continue to be the main driver behind this price action. Last week’s US December Consumer Price Index (CPI) print didn’t dampen those concerns, coming in broadly in line with consensus, up 7% year-on-year and at the highest level in 39 years. Regionally, the European Stoxx 600 Index lost 1%, the S&P 500 Index was down 0.3%, whilst the MSCI Asia Pacific Index, the underperforming region last year, was up 1.6%.

There has been a clear focus on central bank rhetoric at the start of the new year, with investors wary of the speed and extent to which monetary policy will begin to tighten. The key focus last week was on the CPI print out of the United States, which came in at the highest level since June 1982. The print set the tone for Fed speak last week, which was unsurprisingly hawkish as a result.

Fed Governor Christopher Waller agreed with consensus that three rate hikes in 2022 is a “good baseline” if inflation stays high, but indicated that he could see potential for four or maybe five rate hikes. Chicago Fed Bank President Charles Evans and Philadelphia’s Patrick Harker echoed those sentiments, saying that three or four hikes will be needed. Governor Lael Brainard added to the many voices calling for a rate hike as early as March. However, Chair Jerome Powell did say the Fed will continue to “use our tools to support the economy”. Yet, he also added that the Fed balance sheet is far larger than it needs to be, adding that it will be run down sooner and faster than the last cycle. Fed speakers have now gone into a black-out period ahead of its 26 January meeting.

The European Central Bank (ECB) continued to do its best to remain dovish in testing circumstances as President Christine Lagarde reiterated the ECB’s commitment to price stability. However, as energy prices continue to spike in Europe, this position is being made more and more difficult to defend. German Bundesbank Chair Joachim Nagel argued that there is a risk of elevated inflation for longer, and the ECB must act if the inflation outlook warrants tighter policy. Yet, the ECB’s chief economist, Philip Lane, tried to de-emphasise the latest inflation data, saying he did not think the criteria will be met for a rate hike this year.

The focus on central bank rhetoric has driven some significant moves in equity markets in the first two weeks of the year. Sector dispersion has been huge in each region. In Europe, year-to-date sector dispersion between best and worst already stands at 16%. The banks, driven by a better rate environment, are now up 10.1% so far this year. Meanwhile, with some of last year’s winners having been sold to fund the move, health care stocks in Europe are down 5.9% over the same time period. Dispersion is even more extreme in the United States. Energy stocks there are up 16.4%, boosted by rising commodity prices, with West Texas Intermediate (WTI) crude oil notably up 12% year-to-date. At the other end, real estate investment trusts (REIT), a 2021 winner and a yield play, have lagged and are down 6.8% so far this year. It is a similar story in Asia; energy stocks are up whilst health care stocks are down, giving sector dispersion between best and worst of 13%.

Despite the hefty moves in bond yields the previous week, last week’s moves were fairly subdued. The US 10-year Treasury yield was up 2.3 basis points (bps) and the German 10-year yield was down just 0.2% bps.

The question remains for investors: how long will this rotation continue? Central banks are desperately trying to manage expectations into what is going to be an interesting period for monetary policy change. The Fed will likely be the clear focus for investors and with the ECB maintaining its dovish stance, there is significant room for a surprise should inflationary pressures continue, and we could see a more hawkish shift.

Week in Review 

Europe

The factor rotation continued in European equity markets, with value stocks adding another 7% last week (the Morgan Stanley European Value Index is now up 17.5% year-to-date). Hedge funds drove most of last week’s moves, so it was interesting to see the rotation trade continue with long-only investors becoming more active. Market volumes were higher last week, reverting to averages last seen in the second half of 2021. In terms of broader themes, the key focus for markets remains on the Fed’s apparent hawkish shift in the last month. Growth stocks were sold again last week, now down nine out of ten days this year, and so the European Stoxx 600 Index closed the week down 1.1%.

The UK FTSE 100 Index outperformed over the course of last week, up 0.8%, given its weighting in value stocks. Defensive stocks were sold again in favour of more cyclical names. Last week, European stocks saw large investor inflows, helped by the factor rotation. Europe is frequently seen as a proxy for the value factor. It hasn’t all been plane sailing for European capital markets so far this year though.

The factor rotation drove the high-level sector moves last week. Oil and gas stocks were strong, and are finally back at pre-pandemic levels with oil prices fairly resilient. Investors have bought into the rate trajectory and the bank stocks were strong again, despite slightly lower yields in Europe. Basic resources were another notable winner last week as commodities strengthened. The other notable winner was travel and leisure as the COVID-19 picture has improved in Europe. Industrials lagged last week, with growth stocks dragging the sector lower. Personal and household goods were also weaker, with expensive consumer-facing stocks weighing on sentiment. Finally, to complete that theme, retail stocks were also lower, as hedge funds sold the outperformers.

Oil prices were up 6.2% last week as the North Atlantic Treaty Organization (NATO) warned of potential conflict as talks with Russia over Ukraine failed to find a resolution. Russia’s flow of gas to Europe via Ukraine remains at low levels and has the potential to add to concerns about on inflationary pressures due to rising energy prices.

We did see a rise in political risk in the United Kingdom last week, with Prime Minister Boris Johnson coming under heavy scrutiny for attending a garden party at Downing Street during a time of severe lockdown restrictions throughout the country. Some Conservative party members have joined opposition calls for Johnson to resign as his popularity drops. The Conservatives are now firmly behind Labour in the opinion polls, which will also be playing on the minds on the Conservative party. Chancellor Rishi Sunak would be a popular choice to replace Johnson, should he decide to step down. It’s likely that Sunak would pursue roughly similar policies, but in a less erratic fashion. Yet, Johnson is a seasoned fighter so it is unlikely he will step down of his own accord.

United States

US equities saw a choppy week in terms of performance as familiar themes of hawkish Fed speak and inflationary concerns buffeted investors. With that, the S&P 500 Index was down 0.3% last week and ended the week just below its 50-day moving average—recall this has been a recent support level.

Energy markets were a talking point, with WTI crude surging back towards multi-year highs, up 6.2% at US$83.82 per barrel. The move was driven by a combination of tensions between the West and Russia, and a larger-than-expected draw in US inventories. It was no surprise to see the energy sector the best-performing sector, up 5.2% on-the-week and now up year-to-date. The sector laggards were yield plays such as REITs and utilities.

Corporate earnings season is upon us once again, with some of the US banks reporting fourth quarter earnings last week. Both JP Morgan and Citibank disappointed investors on Friday. On the flip side, Wells Fargo performed well thanks to positive earnings.

Looking to macro data beyond the CPI print, we had December retail sales that were weaker than expected. US retail sales fell 1.9% in December month-on-month. This is the biggest drop since February 2021. Reasons suggested for the slump in retail sales include the Omicron variant impact, inflationary pressures, the end of government’s pandemic-related financial programmes, and declines in the savings built up through the pandemic. US consumer borrowing has increased sharply, suggesting individuals are now increasingly relying on credit over savings.

Asia and Pacific

Asian markets were mixed last week with Japan closing the week down 1.24% and China also down1.63%. However, Hong Kong finished the week up 3.79%.

In Japan, concerns about more aggressive monetary policy tightening by the US Fed continued to weigh on sentiment, leading to a similar rotation we saw in Europe and the United States. Confidence was also dented by the government extending the ban on nonresident foreigners entering Japan until the end of February, as well as an apparent sixth wave of the coronavirus hitting Tokyo. The more hawkish Fed contrasts with the dovish stance of the Bank of Japan, which continues to signal its commitment to monetary easing and is unlikely to raise short-term interest rates anytime soon.

The Shanghai Composite Index closed the week down 1.6%, weighed on by headlines about refinancing difficulties in the country’s troubled property sector. China’s largest banks have grown more selective about funding real estate projects by local government financing vehicles, while several developers scrambled to obtain creditors’ consent for maturity extensions and exchange offers. Other developers have intensified fundraising campaigns as traditional financing routes like presales have dried up.

Evergrande, the world’s most indebted property company, secured a crucial approval from onshore bondholders to delay payments on one of its bonds. Reuters reported that Shimao Group, which missed payment on a US$101 million trust loan earlier this month, will meet with creditors to vote on payment extension proposals after denying reports of a fire sale. Credit rating agencies Moody’s and S&P downgraded their ratings on Shimao again last week, and S&P said it withdrew its rating at the company’s request.

In economic news, consumer and producer price inflation slowed more than expected in December, while new bank lending fell more than expected. China’s trade surplus rose to a record US$676.43 billion in 2021, the highest since 1950, when the country began recording data. The moderating inflation signs raised expectations that China’s policymakers would lower interest rates and possibly the required reserve ratio for banks to bolster the economy. Any easing in China would mark a divergence with policy in the United States., where Fed officials have telegraphed the central bank’s intention to raise interest rates several times this year to curb a surge in inflation.

On the pandemic front, China suspended dozens of international flights and issued more restrictions in response to the global surge in omicron cases. Hong Kong, which had reported no local infections for months, reimposed some social and travel restrictions after a string of positive cases, dealing a setback to the city’s reopening hopes. Shanghai curbed tourist activity as it rushed to head off local infections as imported cases rose.

Week Ahead

Holidays   

Monday 17 January: US (Martin Luther King Day)

Macro Week Ahead Highlights

Monday 17 January:

• Norway trade balance
• Switzerland total sight deposits

Tuesday 18 January:

• UK labour market statistics
• Eurozone EU27 new car registrations
• Italy trade balance EU
• Germany ZEW Survey current situation

Wednesday 19 January:

• UK CPI inflation
• Germany CPI
• Switzerland producer and import prices
• Italy current account balance
• Eurozone construction output

Thursday 20 January:

• Euro area final CPI inflation
• European central bank monetary policy accounts
• Netherlands unemployment rate
• Germany Producer Price Index
• France manufacturing confidence
• Spain trade balance
• US weekly jobless claims

Friday 21 January:

• UK retail sales
• UK consumer confidence

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All investments involve risks, including the 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.

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Past performance is not an indicator or guarantee of future performance. There is no assurance that any estimate, forecast or projection will be realised.

This article reflects the analysis and opinions of Franklin Templeton’s European Trading Desk as of 17 January 2022, 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. 

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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.