Jean Boivin – Head of BlackRock Investment Institute together with Wei Li – Global Chief Investment Strategist, Axel Christensen – Chief Investment Strategist for Latin America and Nicholas Fawcett – Macro Research, 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
EMs lead the way: Developed market central banks are starting to cut policy rates. We think they will have to keep them higher for longer, as some emerging markets already are.
Market backdrop: U.S. stocks hit a fresh record high and 10-year U.S. Treasury yields slid last week after U.S. jobs data showed moderating wage growth.
Week ahead: We watch the U.S. CPI data for June this week to see where services inflation will settle. We think it will bounce back from its recent unusually low levels.
The Federal Reserve looks set to cut interest rates later this year, buoyed by inflation easing further after Q1 surprises, as this week’s CPI data should reaffirm. Yet looking ahead, the Fed and its developed market (DM) peers will have to keep rates higher for longer as inflation settles above their 2% targets, we think. Some emerging market (EM) central banks are facing this fact, pausing their rate cuts with rates well above pre-pandemic norms. We lean into quality in fixed income.
Falling inflation has allowed DM central banks, like the European Central Bank, to start cutting rates recently. The Fed and Bank of England are likely to cut later this year. We think the odds of a Fed rate cut in September are marginally higher after the June U.S. job data. An average of about 180,000 monthly jobs have been added in the past three months – a level we think the economy can sustain for now without risking wage pressures given the surge in immigration. Yet we don’t think that pace of immigration can persist. Plus, the pace of wage growth is still consistent with inflation above 2% in the medium term. The Fed has upped its long-term policy rate projections as it and its DM peers accept they’ll have to keep rates higher for longer due to supply constraints. EM central banks have been ahead in both hiking and confronting that reality after the pandemic. See the chart.
Many EM central banks started cutting rates earlier this year – some as early as 2023 – as growth has moderated and with support from cooling inflation. Now those EM central banks are nearing the end of their easing cycles as they confront varied constraints on how much they can cut rates. EM central banks can only go so far in cutting rates, especially when DM central banks – notably the Fed – are holding interest rates steady or slow to cut. Such a policy divergence can hurt the local currency against the U.S. dollar, and some economies are more sensitive to the resulting inflation from a weaker currency.
Higher for longer
Some EM central banks have highlighted other concerns as the driving force behind plans to pause rate cuts. Brazil’s central bank held rates at 13.75% for a year after launching hikes in 2021 from a low of 2%. It has since cut rates to 10.5% as inflation has fallen to target. But it halted rate cuts in June, citing questions over the impact of loose government fiscal policy on inflation. Poland’s central bank has frozen rates at 5.75% since October after two rate cuts. Why? Uncertainty over how the government ending measures to shield households from high energy costs will affect inflation, prompting the Polish central bank to boost its inflation forecast for next year. We see both EMs and DMs facing structural sources of higher inflation after the pandemic, including elevated public debt and geopolitical tensions leading to a rewiring of supply chains.
Higher-for-longer rates does not have to be bad news for risk assets, as we’ve seen this year. Top tech firms beating earnings expectations due to the artificial intelligence theme helped push stocks to record highs even as bond yields have risen on reduced Fed rate cut expectations. We stay overweight U.S. stocks and prefer quality income in short-term government bonds and credit. We went overweight EM hard currency debt, typically issued in dollars, in August 2023 just as EM central bank rate cuts were gearing up. We expected local currencies to fall against the dollar, hurting EM local currency debt. As that played out, EM hard currency debt has performed well. But we’re reassessing our view as EM central banks pause rate cuts.
Bottom line
We think DM central banks will keep policy rates higher for longer than before the pandemic – just like EM central banks are doing now. We stay overweight EM hard currency debt yet stand ready to pivot as central banks shift policy.
Market backdrop
U.S. stocks hit a fresh record high and gained nearly 2%. Ten-year U.S. bond yields slid to 4.27% after the June U.S. jobs report and are in a rough 4.20-4.50% range over the past month. The data showed moderating wage growth but still at levels consistent with inflation staying above 2%. UK stocks were little changed after the Labour Party’s landslide election victory. France’s main stock index rose nearly 3% on the week before the final round of the parliamentary election.
June U.S. CPI is in focus this week as Fed officials have reaffirmed that the central bank’s next move depends on data. Core services inflation, excluding housing, is proving volatile. It was unusually low last month but is likely to bounce back, so we’re watching to see if it settles at a level consistent with 2% inflation.
Week Ahead
July 10: China CPI and PPI; Japan corporate goods prices
July 11: U.S. CPI
July 12: U.S. University of Michigan consumer sentiment survey; China trade data
July 10-17: China total social financing
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