Wei Li, Global Chief Investment Strategist of the BlackRock Investment Institute together with Scott Thiel, Chief Fixed Income Strategist, Axel Christensen, Chief Investment Strategist LatAm & Iberia and Baeta Harasim, Senior Investment 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.

Key Points:

EM local debt’s appeal: We like emerging market (EM) local debt within an overall bond underweight. Much monetary tightening has been done, and valuations are compelling.

Market backdrop: U.S. Treasury yields hit new three-year highs last week, and equities fell. We still think stocks can weather the yield rise in the inflationary backdrop.

Week ahead: U.S. and euro area data this week may show how the supply shock of the Ukraine war is affecting growth. We expect Europe to be hit harder than the U.S.

Inflation and hawkish central bank talk have spooked investors and led to bond losses not seen since the 1980s in developed markets (DMs). EM debt has also suffered, even ahead of the stress test of higher DM policy rates. The good news: Many EM central banks were early in raising rates to try to rein in inflation. This approach has created compelling yield and currency valuations, in our view. Broad indexes hide a lot of differentiation, so it’s key to analyze the underlying exposures.

A tale of different EMs

Emerging market local debt vs. U.S. Treasuries total returns, 2022

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, April 2022. Notes: The chart shows the total returns for emerging market local-currency bonds compared with U.S. Treasury bonds based on the JP Morgan GBI-EM Global Diversified and regional (LatAm and Europe) indexes and Bloomberg U.S. Treasury USD index.

It’s been an annus horribilis for bonds everywhere this year – except in some corners of the emerging world. Why? Scarcity inflation has arrived. Supply shocks have created shortages of goods, energy and food that are driving up prices. This has spurred DM central banks to signal faster policy normalization than markets expected and resulted in bond yields rocketing upward. Local-currency EM debt (the red line in the chart) has suffered alongside U.S. Treasuries (green line) so far this year. It’s key to realize broad EM indexes hide a lot of differentiation. Local-currency debt of commodities producers such as Latin America (yellow line) and the Middle East & Africa have actually posted gains this year, outperforming debt of commodities-consuming Asia and Europe (purple line). The latter was directly hit by the fall-out of Russia’s invasion of Ukraine.

Rate hike risk

How about the risk of the Fed’s upcoming rate hikes? This has often spelled trouble for EM assets. Investors have tended to demand a higher risk premium for holding them. Fed tightening also has frequently come with a stronger U.S. dollar, pressuring EM entities with hard-currency borrowings. We see the Fed’s impact as more limited this time. First, the Fed is rightly racing to normalize policy, but we believe it won’t fully deliver on its hawkish rate hike plans in the end. Second, we expect the sum total of rate hikes to be historically low given the level of inflation.

We also see a strong starting position for EM debt, given cheapened EM currencies, improved external balances, decreased foreign ownership and attractive coupon income. The main reason: Many EM central banks have been ahead of the curve in raising interest rates to fight inflation, as we noted in Liftoff? EM has already taken off of November 2021. This means they are much further along on the path to policy normalization than DM central banks. Real yields, or inflation-adjusted yields, have been edging into positive territory in some countries. 

What are the risks? DM central banks could push rates to levels that destroy growth in an effort to rein in inflation. This would deal a blow to EM countries already struggling with high import prices of commodities and rising debt piles as a result of COVID relief programs. Alternatively, some EM countries could see runaway inflation, forcing their central banks to slam the brakes. And some could face social unrest in the face of fast-rising prices of food and other basic goods.

It’s important to realize broad EM indexes hide a lot of differentiation. EM equity indexes, for example, are heavily weighted toward Asia. The benchmark GBI EM Diversified local-currency index has a 10% cap on any one sovereign issuer, giving more diversification and exposure to commodities exporters. It also means investors may need to go beyond indexes to get the exposures they are bullish on – and avoid the ones they have little confidence in. EM assets tend to offer fertile ground for security selection, we find, compared with heavily researched asset classes such as DM large-cap equities.

Our Bottom Line

We maintain a modest overweight to EM local-currency debt amid an overall underweight to bonds. Much monetary tightening is already done, and valuations are compelling. We are neutral hard-currency EM debt. It is sensitive to rising U.S. rates, and valuations are now less attractive vis-à-vis U.S. credit. We prefer to take EM risk in debt, rather than equities. We prefer DM stocks because of EM’s challenged restart dynamics, inflation pressures and tighter policies.

Market Backdrop

Yields on 10-year U.S. Treasuries rose to near 3% last week, levels not seen since late 2018. Equities ended down as the first-quarter earnings season gathered steam. We still think stocks can perform even as yields rise in the inflationary backdrop. The IMF forecasts much higher inflation and weaker growth, especially in Europe, due to the supply shock emanating from the Ukraine war. We believe downside risks to growth in China have increased amid Covid lockdowns.

This week’s highlights will be U.S. and euro area inflation and GDP data releases that further reveal the growth impact of the stagflationary supply shock from the war in Ukraine. We expect Europe to feel the hit more than the U.S. China manufacturing data will likely reflect how a spike in COVID cases is restricting activity.

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 22, 2022. 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 Brent crude, ICE U.S. Dollar Index (DXY), spot gold, MSCI Emerging Markets Index, MSCI Europe Index, Refinitiv Datastream 10-year benchmark government bond index (U.S., Germany and Italy), Bank of America Merrill Lynch Global High Yield Index, J.P. Morgan EMBI Index, Bank of America Merrill Lynch Global Broad Corporate Index and MSCI USA Index.

Week Ahead

• April 26: U.S. durable goods and consumer confidence data
• April 28: Germany CPI and HICP; U.S. GDP Q1 Advance; Bank of Japan meets
• April 29: Euro area GDP and HICP Flash; U.S. consumption; Russia central bank meeting
• April 30: China manufacturing PMI
  
  

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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 April 25th, 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.

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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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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.

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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

Equity markets traded lower last week as hawkish comments from central bankers both in the United States and Europe weighed on sentiment. In addition, further COVID-19 lockdown restrictions in China and the bleak picture in Ukraine gave investors further reason to step back from markets. In that context, the MSCI World Index was down 2.6% last week, the STOXX Europe 600 Index was down 1.4%, the S&P 500 Index was down 2.8% and the MSCI Asia Pacific Index was also down 2.6%.

Victory for Macron in French Elections

On Sunday, the French election went as polls predicted, with current President Emmanuel Macron winning 58% of the vote, beating opponent Marine Le Pen’s 42%. Polls had widened in favour of Macron in the past week, and as a result, the CAC40 Index rose last week. Macron is the first French president to be re-elected since Jacques Chirac in 2002. That said, France remains a divided country, with 72% turnout the lowest since 1969 and three million voters casting spoilt or blank ballots. Macron said his government would have to “answer their choice to refuse to choose”.

Victory for President Macron is certainly the more market-friendly outcome, given his economic reform agenda and support for the European Union (EU) cohesion.

Given investors had anticipated the election outcome and it was largely priced into the market, the CAC40 Index traded lower after the results came in.

Attention will now turn to parliamentary elections in June where Macron will aim to hold on to his majority.

Hawkish Central Bank Rhetoric

Last week saw several central bankers across the globe coming out with hawkish commentary, outlining the path ahead.

In the United States, Federal Reserve (Fed) Chair Jerome Powell said that a 50 basis-point (bp) hike is on the table for the May meeting, arguing that it’s appropriate to be moving a little more quickly with front-end loaded policy. The Fed’s Mary Daly said the Federal Open Market Committee (FOMC) still needs to deliberate whether rate hikes should be 25 bps, 50 bps, or 75 bps.

St. Louis’ Fed President James Bullard said inflation expectations threatening to become unmoored, although he also said Fed isn’t as far behind the curve as some think. In addition, Bullard talked up potential for a 75 bp hike and reiterating that he favours a 3.5% base rate (much higher than the suggested neutral rate). Fed funds futures are now pricing in 9.75x 25 bp hike by the end of the year (up from 8.59x at the end of last week), and there seems to be a growing consensus that quantitative tightening (QT) will be announced in May and begin in June.

Interestingly, we had some European Central Bank (ECB) members breaking rank to strike a more hawkish tone. Vice President Luis De Guindos suggested that quantitative easing (QE) can end in July, and that rate hikes could commence later in the month. Latvia’s governor Martins Kazaks said that a rate increase was  possible as soon as July, although he is a recognised hawk. Bundesbank President Joachim Nagel said that the ECB may raise rates early in the third quarter if it decides to end bond purchases at the end of June. Money markets have now priced in 24 bps worth of ECB hikes at the July meeting, up from 11 bps last week.

On the back of these comments, we saw bond yields continue to push higher this week, with the US 10-year yield up 7.2 bps, the German 10-year yield up 13 bps, the French 10-year yield up 8.9 bps, and the UK 10-year yield up 7.3 bps.

The Week in Review

Europe

European equities sold off last Friday to close the week down 1.4% overall. Stock markets faced a number of headwinds, including increased central bank hawkishness, an uncertain corporate earnings season, and the ongoing destruction of Ukrainian towns and cities by Russian forces. Hawkish statements from FOMC members largely drove the late selloff last week.

The CAC40 Index (down 0.1%), was the best-performing European market last week as polls moved in Macron’s favour ahead of the weekend vote.

It is early days in the latest European earnings season, with 10% of the STOXX Europe 600 Index having reported (46 out of 442 which are due to report). Reports have surprised to the upside so far, with more companies beating than missing expectations across all four measures: sales surprise, sales growth, earnings surprise and earnings growth. In terms of sectors, staples and banks have beaten, whilst miners have missed expectations so far.

Turning to the war in Ukraine, the Financial Times reported over the weekend that Russia’s President Putin is no longer interested in diplomatic efforts and is focused on territorial gains. The World Bank estimates that physical damage to Ukraine and its infrastructure has reached roughly US$60 billion.

Sector performance divergence was significant again last week. Construction and materials and industrials stocks rose amid better-than-expected earnings reports last week. Banks were also higher amid a rising interest rate environment. In terms of laggards, basic resources stocks significantly underperformed  last the week. Once again, earnings were the key driver, with a number of companies missing estimates through the week, citing cost and production issues.

The latest comments out of China with regards to COVID-19 restrictions were also particularly downbeat, talking of lockdowns rather than stimulus. Health care stocks also underperformed last week amid profit-taking and as defensives came under pressure. Also, as COVID-19 restrictions eased once again in Europe, Goldman Sachs’ Stay at Home index was down 6% last week and is down 30% year-to-date.

Weak UK macro data saw the sterling slump to lowest level since 2020. UK GfK consumer confidence balance fell to a reading of -38 in April, which was the second lowest on record—just one point above the -39 reading in July 2008 ahead of the global financial crisis (GFC). In addition, UK Retail March Sales fell 1.4%. Markets will be watching the Bank of England meeting 5 May, when a 25 bps rate hike is expected.

United States

Last week was tough for US equities, with headwinds in the form of hawkish Fed commentary (as discussed) and some notable earnings disappointments. The  S&P 500 Index was down 2.8% on-the-week and the Nasdaq 100 Index declined 3.9%, down 10% for the month, its worst monthly performance since the GFC. Rising bond yields hurt technology names, and streaming service Netflix plunged -37% last week amid an earnings miss.

Looking at sector performance, only real estate investment trusts (REITs) and consumer staples were in positive territory. Meanwhile, communication services lagged amid the Netflix earnings miss, and energy stocks fell amid a drop in  crude oil prices.

The CNN Fear & Greed index has slipped back into Fear territory, though still comfortably above Extreme Fear levels. Something to keep an eye as we progress through earnings season.

ASIA-Pacific

Last week was poor across Asian markets in general, with the MSCI Asia Pacific Index closing the week down 2.5% amid a late selloff on concerns around last Thursday’s hawkish Fed and ECB comments.

Mainland Chinese stocks closed the week down 3.87% amid continued economic fallout caused by ongoing COVID-19 lockdowns, pressure on the property sector and policy easing disappointment. Rising  COVID cases in Beijing sparked jitters about an unprecedented lockdown of the capital, with policymakers racing to avert a Shanghai-style crisis that has already wrought havoc on the financial hub.

Consequently, analysts continue to downgrade their estimates for gross domestic product (GDP). On Monday, the People’s Bank of China (disappointingly) lowered its reserve requirement ratio (RRR) for financial institutions and certain regional banks, effective 25 April. It also announced a number of measures to support individuals and small businesses.

The Chinese currency continued to weaken last week (not helped by the Fed’s hawkish comments) and is likely to weaken further this year due to slowing exports, faster US interest-rate hikes and the potential capital outflows from emerging markets.

Hong Kong’s market reopened on Tuesday after the Easter break and closed last week lower as pressure continued on the technology sector over government regulation. A potential delisting of US-traded shares also dampened sentiment.

Japan’s market fared better, closing the week up 0.04%. However, yen weakness continues to attract scrutiny, with Japanese government officials sounding more warnings about the negative economic consequences. The Bank of Japan (BoJ) has vowed to continue prioritising monetary easing until the price stability target is achieved in a stable manner. Consumer Price Index (CPI) inflation continued to lag other major developed economies—the core CPI in March came in at  +0.8% year-over-year—remaining a key factor behind the BoJ’s continued pursuit of its loose monetary policy. The BoJ bought Japanese government bonds to defend the upper limit of its interest rate target range and announced fresh bond-buying plans.

Elsewhere, Samsung drove the South Korean market higher, and semiconductors underpinned Taiwan’s market, which closed up 0.12% last week.

The Week Ahead

Corporate earnings should continue to dominate attention in the United States and Europe this week, with a significant number of companies reporting. Of note, in the United States we have technology heavyweights Apple, Amazon, Microsoft and  Alphabet all reporting earnings.

Last week Fedspeak was a market driver, but as we enter the blackout period ahead of the 4 May FOMC meeting, it will be quieter on this front.

Looking at macro data, we have a number of European data points that will be important given recent ECB commentary. Away from Europe, Chinese Industrial Profits on Wednesday and US GDP on Thursday will be important data points.

Monday 25 April  

• Germany Ifo survey (expectations)
• Spain Producer Price Index (PPI)
• Eurozone construction output

Tuesday 26 April

• UK public finances (Public Sector Net Cash Requirement)
• US durable goods and manufacturers’ shipments

Wednesday 27 April

• Sweden trade balance and unemployment rate
• US housing inventories
• China industrial profits

Thursday 28 April

• Spain Consumer Price Index (CPI)
• Germany CPI EU Harmonized
• US jobless claims and GDP
• Japan retail sales and industrial production (IP)

Friday 29 April

• France consumer spending, GDP and CPI
• Italy GDP and CPI
• Spain GDP and retail sales
• Germany GDP
• Eurozone GDP and CPI estimate
• US personal income

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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 25 April 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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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.