Jean Boivin, Head of the BlackRock Investment Institute together with Wei Li, Global Chief Investment Strategist, Alex Brazier, Deputy Head of the BlackRock Investment Institute 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.

Key Points:

Reducing Risk: We slightly reduce risk on a worsening macro outlook. We upgrade European government bonds and investment grade credit, and downgrade Chinese assets.

Market backdrop: The Fed raised rates by 0.5% last week – the largest increase since 2000 – and signaled similar rises ahead. Long-term yields shot up and stocks gyrated.

Week ahead: Data this week may show increasing U.S. core inflation on likely higher services and housing costs. We see inflation settling at a higher level than pre-Covid.

Inflation and hawkish central bank talk have spooked investors and led to bond losses not seen since the U.S. wages are growing at the fastest clip since the 1980s. Is this the start of a “wage-price spiral” – a We nudge down risk on a worsening macro outlook: the commodities price shock and a growth slowdown in China. We also see little chance of a perfect economic scenario of low inflation and growth humming along. Last week’s market rout shows investors are adjusting to this reality. We upgrade investment grade (IG) credit and European government bonds to neutral as we see opportunities there. We downgrade Chinese assets and Asia fixed income as we consider them riskier now.

Yield on offer

U.S. labor costs, 2019-2021

Bonds are generally not attractive in inflationary times, and we remain overall underweight the asset class. Yet this year’s dramatic sell-off has restored some value in pockets of the market, in our view. First, we have warmed up to European government bonds because we believe market expectations of rate hikes by the European Central Bank (ECB) are too hawkish. We see the energy shock hitting Europe hard – and causing the ECB to move very slowly in normalizing policy. We also see the asset class as a buffer against the growth shock, after downgrading European equities in March. Second, we are seeing some value in IG credit as annual coupon income is nearing 4%. That’s the highest in a decade, as the red line in the chart shows, driven by a rise in Treasury yields (the pink area in the chart) and a widening of spreads (yellow). Crucially, we remain underweight U.S. Treasuries. We see the yield curve steepening on further rises in long-term yields as investors want more compensation for holding long-term bonds amid inflation.

The big picture

The Ukraine war, a global energy shock and the risk the Fed tries to fight the supply-driven inflation have sparked a reassessment of macro scenarios among market participants. The root cause is inflation in a world shaped by supply. It started with the supply shock from the restart of economic activity. Russia’s invasion of Ukraine added a broad commodities price shock on top of that. The Fed and other central banks are facing a tough choice now: suppressing supply-driven inflation means raising rates so high that they destroy growth and jobs. We believe the Fed ultimately won’t raise rates beyond neutral – a level that neither stimulates nor decreases economic activity – to avoid such a scenario. This means it will have to live with inflation that we see settling at a higher level than pre-Covid. We believe the eventual sum total of rate hikes will be historically low, given the level of inflation. This means we still favor equities over fixed income.

At the same time, we recognize risks have risen. The commodities price shock is set to hit growth, especially in Europe and emerging markets that are commodities importers. The Fed rightly is fast normalizing policy but could slam the brakes on the economy if it chooses to fight inflation. It’s tough to see a perfect outcome. Getting inflation down to pre-Covid levels likely means recession, as the Bank of England warned last week. And the growth outlook for China, the world’s second-largest economy, is quickly deteriorating amid widespread lockdowns in an attempt to halt the spread of Covid.

We are downgrading Chinese stocks and bonds to neutral on the deteriorating macro outlook. We see a growing geopolitical concern over Beijing’s ties to Russia. This means foreign investors could face more pressure to avoid Chinese assets for regulatory or other reasons. We previously kept our modest overweight on Chinese assets because we saw improved valuations making up for the risks. The rapidly worsening outlook for China’s growth on widespread lockdowns to curtail a COVID spike has changed this. Lockdowns are set to curtail economic activity. China’s policymakers have heralded easing to prevent a growth slowdown – but have yet to fully act. And yields on Chinese government bonds have fallen below those on U.S. Treasuries amid policy divergence, eroding their previous appeal as a source of potential coupon income.

Bottom line

We are nudging down risk amid the commodities price shock, deteriorating growth in China and tough trade-offs for central banks. We upgrade European government bonds and IG credit to neutral as we see tactical opportunities there. We downgrade Chinese assets to neutral due to geopolitical concerns and a worsening macro outlook. Overall, we remain overweight equities, with a preference for U.S. and Japanese stocks, and underweight U.S. Treasuries.

Market backdrop

The Fed raised its policy rate by 0.5% last week and said it would start winding down its balance sheet by not re-investing the proceeds from maturing bonds. Chair Jerome Powell signaled 0.5% hikes at the next two meetings in an effort to rein in inflation, and dismissed larger increments for now. We believe the sum total of hikes will be historically low, but see long-term yields rising further as investors demand higher compensation for holding long-term bonds amid persistent inflation.

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 May 5, 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

• May 9: China trade data
• May10: Germany ZEW survey; China credit and money data
• May 11: U.S. consumer prices; China consumer and producer prices
• May 12: UK GDP release
  

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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 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.

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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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

Last week saw some extreme moves in equity markets as investors digested several central bank announcements, most notably the Federal Reserve (Fed) meeting on Wednesday. Last Thursday saw a sharp selloff in global equities, as fears around central bank policy errors regarding a stagflation environment weighed on sentiment. The ongoing COVID-19 lockdown in China and the Russia-Ukrainian war heightened investor uncertainty. In that context, all markets traded lower last week, with the MSCI World Index down 1.2% (down 14% year-to-date), the STOXX Europe 600 Index down 4.5%, the S&P 500 Index down 0.2% and the MSCI Asia Pacific Index down 2.7%.

Central Banks in Focus

Fed: Last Wednesday’s announcement was largely in line with market expectations, as the Fed increased interest rates by 50 basis points (bps), taking the fed funds rate to 1% (as expected). The US central bank also set out plans to reduce its balance sheet. This was the first time it had raised rates by 50 bps since 2000, and the first time since 2006 rates were raised in back-to-back meetings. The Fed now aims to get back to its “neutral interest rate” between 2% and 3%, although Chair Jerome Powell said a neutral rate was “not something we can identify with any precision”.

Regarding the Fed’s US$9 trillion balance sheet, it announced quantitative tightening at US$47.5 billion runoff (marginally higher than consensus) starting on 1 June (marginally later than expected, likely offsetting the faster initial pace) rising to US$97.5 billion after three months (broadly in line with expectations).

Looking ahead, Powell said 50 bp rate increases would be “on the table for the next couple of meetings” but, when asked about a larger increase, he said the Federal Open Market Committee (FOMC) was not “actively considering” a 75 bp rate hike.

US markets initially focused on the comment to rule out future 75 bp hikes as dovish and, last Wednesday saw a knee-jerk 3% rally in the S&P 500 Index, only for it to reverse the following day as investors appeared to shift focus to the overall hawkish path ahead in a difficult economic context. On the economic outlook, the Fed feels that the US economy is strong enough to withstand the measures it is taking. However, US Treasury Secretary Janet Yellen said Powell would need to be “skillful and also lucky” to see the US economy have a soft landing.

Bank of England (BoE): Following on from the Fed rate increase last Wednesday, the BoE announced its interest-rate decision on Thursday. Consensus was for a 25 bp rate hike and the BoE didn’t disappoint, raising the benchmark rate by 25 bps to 1%—the fourth consecutive rate rise. Interestingly, six monetary policy committee members voted for 25 bps and the remaining three for 50 bps, giving the announcement a slightly hawkish feel (compared to the FOMC, which many thought had a slightly dovish feel to it). In the press release, there was some (depressing) commentary warning of growing recession risk, and the BoE also forecast inflation to hit 10% by the end of the year (the highest rate since 1982).

However, some have been questioning the BoE’s (very bearish) gross domestic product (GDP) projections, which are at odds with the Bloomberg consensus and, importantly, the United Kingdom’s own Office for Budget Responsibility (OBR). Maybe the BoE is being overly (or ”conservatively”) pessimistic, or maybe the market consensus is being overly optimistic. Either way, it seems there is a very rocky road ahead and we are at the mercy of geopolitical and pandemic developments.

European Central Bank (ECB): The focus will now turn to the next ECB meeting on 9 June.  The change in rhetoric from ECB members has been notable, with a much more hawkish stance. Last week, Austrian Central Bank Governor and ECB Governing Council member Robert Holzmann said the ECB planned to discuss an interest-rate rise at its June meeting and will “probably do it.” The market now is factoring in three ECB rate hikes this year.

The Week in Review

Europe

Last week global equities made new year-to-date lows, so unsurprisingly it was a tough week for European equities. The STOXX Europe 600 Index declined 4.5% on the week. Clear headwinds included central banks raising rates into stagflation and a gloomy outlook from the BoE, causing growth and consumer stocks to buckle. Once again, the dispersion between sectors was extreme, with energy remaining one of the few hideouts, up 3.2% last week amid higher crude oil prices and positive earnings reports. Consumer products (particularly luxury goods) and real estate slumped.

It was another big week for corporate earnings, with the energy space the clear beneficiary of some good numbers (e.g., BP and Shell). In contrast, the market was unforgiving on any earnings misses, particularly so with consumer stocks (e.g., Adidas).

Once again, we saw outflows from European equities, continuing the streak.

In Ukraine, the Russian advance in the east made marginal gains, and with no mention of peace talks anymore, a long, drawn-out campaign into the summer seems probable. The impact of this on commodity and food prices is clear. Of note, fertilizer prices are now at all-time highs. In addition, the impact on supply chains was highlighted when German car manufacturer Volkswagen stated it had “sold out” of electric cars for 2022 after supply chain bottlenecks hit production.

Looking to other asset classes, European credit continues to show signs of stress amid fears over the region’s economic outlook. In addition, since 2020 the ECB has backstopped credit markets with its asset purchasing programme; as it is set to conclude in the second half of 2022, there are serious concerns over the impact of its disappearance from the market.

One of the big stories last week was the slump of the UK sterling, which fell 2.5% last week. The gloomy BoE message triggered the move, as downside risks to growth continue to rise even as the UK Consumer Prices Index (CPI) is expected to rise above 10%.

European government bond yields continue to sharply widen, with the German 10-year bund going from negative territory in March, up to 1.13%. Peripheral yields have also widened, with the spread between 10-year BTPs and bunds crossing 200 bps. This will be a concern for authorities in Italy, as its economy is heavily exposed to Russian energy imports.

Macro data for the region was mixed last week. Eurozone Purchasing Managers’ Index (PMI) manufacturing data was a little better than estimated at 55.5, but new orders had the lowest reading since June 2020. German year-over-year March factory orders also dropped far more than expected. The consumer has also been under pressure, with retail sales in Germany falling unexpectedly in March.

United States

The S&P 500 Index closed last week down 0.2% to record its fifth consecutive weekly loss, its worst run since 2011. The tech-heavy Nasdaq Index also fell 1.3%, now with five straight weeks of >1% declines. Risk-off sentiment was clear when we look at fund flow data, which showed continued US equity outflows. Focus for the week was on the Fed announcement, which initially sparked a rally in equity markets with a couple of dovish signals. The deterioration in macro datapoints was cited as the reason behind the subsequent selloff in global equities, as data out of China and Europe disappointed. Despite the dramatic moves last week, there was no sharp rise in the VIX Index, which closed at 30.19.

Meanwhile, the April US employment report was roughly in line with expectations, with 428,000 jobs added. However, there were a couple of misses within the report. There was a decline in household employment and labour-force participation, which raised concerns on the future growth of the jobs market.

US equities were very mixed at a sector level last week. Energy closed the week with strong gains helped by the rally in oil prices on the prospect of a European Union (EU) embargo on Russian oil, as well good earnings. Utilities and communication services also fared relatively well last week. At the other end, real estate investment trusts (REITs) underperformed, closing the week lower with interest rates on the rise and as US Treasury yields moved higher. Consumer discretionary stocks were also weak, with retailers under pressure. The Goldman Sachs Non-Profitable Technology Index traded down on the week as well.

Meanwhile, earnings season remained in full force, with nearly 90% of the S&P’s market cap having reported first-quarter earnings. So far, we are seeing more companies beating expectations than missing. Value and growth stocks are delivering similar revenue growth as in the first quarter; however, value stocks are delivering stronger earnings-per-share (EPS) growth. Within the United States, more globally oriented companies are delivering faster earnings growth than their more domestically oriented peers.

In terms of credit markets, the US 10-year Treasury bond crossed 3%, rising to levels last seen in November 2018. Global credit markets remain under pressure, driven by fears of slowing economic growth, faster inflation and subsequent interest rate rises. Last week was the fifth consecutive week of losses for credit markets, the longest losing streak in more than three months.

ASIA-Pacific

Although markets in China and Japan were closed for most of last week amid holidays, the week was marked by declines.

China’s market reopened on Thursday and declined on Friday. The government’s strict zero-COVID policy continues to hit economic growth, jobs and the entire supply chain. As a guide to how impactful the restrictions have been, spending over China’s five-day Labour Day holiday plummeted 43% from a year earlier to CNY 64.7 billion, or roughly US$9.8 billion. This follows the Caixin and official purchasing managers’ surveys, which showed manufacturing and services contracted at a significant rate in April.

US-China relations continue to be stretched, as US regulators added more than 80 companies to an expanding list of firms that face possible expulsion from American exchanges because of Beijing’s refusal to allow access to the businesses’ financial audits. Also, investors continue to be wary of possible sanctions on China over their tacit support of Russia, with Chinese regulators holding emergency meetings with domestic and foreign banks to discuss how they could protect the country’s overseas assets from US-led sanctions.

Later in the week, the market sold off as the government reaffirmed its commitment to a zero-COVID strategy, and amid the Fed’s rate hike and bearish BoE outlook.

Yields on Chinese government bonds declined after the People’s Bank of China said it would use incremental policy tools to support steady economic growth and stabilize employment and prices. The CNY weakened slightly against the US dollar from the prior week as corporates rushed to hedge after the currency slumped 4% in April, its steepest monthly drop since foreign exchange reforms in 1994.

Japan’s market closed the week up 0.58% despite the holidays and the volatility induced by the Fed’s decision to implement the first 50 bps raise since 2000. The yield on the 10-year government bond rose to 0.24%, from 0.21% at the end of the previous week. The yen finished the period slightly weaker, at around JPY130.51 vs. the US dollar, continuing to hover at a two-decade low.

Elsewhere, in Australia the Reserve Bank of Australia raised rates by 25 bps to 35 bps last Tuesday, and short-dated bonds traded off hard as a result.

The Week Ahead

In Europe, focus ahead will be on the German ZEW economics expectations survey, the UK Sterling and Eurozone Industrial Production (IP) reports. Rhetoric from the ECB will continue to be a focal point ahead of its June meeting. Elsewhere, US and Chinese Inflation data on Wednesday will be closely watched.

In terms of politics, commentary around the proposed EU ban on Russian oil imports will be important to track, given the potential economic impact.

Monday 9 May   

• UK BRC sales LFL
• French trade balance

Tuesday 10 May

• Germany ZEW Expectations Survey
• Italian IP

Wednesday 11 May

• German CPI
• US CPI
• China CPI

Thursday 12 May

• UK GDP
• UK imports and exports
• US Producer Price Index (PPI)

Friday 13 May

• French CPI
• Spanish CPI
• Euro area Industrial Production

Franklin Templeton Key risks & Disclaimers:

What Are the Risks?

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.

Any companies and/or case studies referenced herein are used solely for illustrative purposes; any investment may or may not be currently held by any portfolio advised by Franklin Templeton. The information provided is not a recommendation or individual investment advice for any particular security, strategy, or investment product and is not an indication of the trading intent of any Franklin Templeton managed portfolio.

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 8 May 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.