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BlackRock Commentary: Looking through the Fed’s signals

Jean Boivin – Head of BlackRock Investment Institute together with Wei Li – Global Chief Investment Strategist, David Rogal – Portfolio Manager, Global Fixed Income 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

Data dependent: We look to incoming data to determine where the Federal Reserve will go, rather than its policy signals. Solid corporate earnings keep us overweight U.S. stocks.

Market backdrop: U.S. stocks clawed higher thanks to earnings beating expectations, even as the Fed meeting confirmed we’re in a structurally higher interest rate environment.

Week ahead: We expect the Bank of England to hold rates steady this week. Markets have pared back their expectations of rate cuts this year due to slowly falling inflation.

Q1 inflation surprises have pushed the Fed to flip on its December view and accept that interest rates will have to stay high for longer at last week’s meeting. We’re in a world shaped by structural forces and supply – creating greater uncertainty for the Fed and markets. That’s why we eye new data, not Fed signals, to gauge the policy path. We see high-for-longer rates, a view markets now reflect. We stay overweight U.S. stocks as solid corporate earnings help offset pressure from high rates.

At its December meeting, the Fed’s communications and its economic forecasts all signaled that inflation would fall toward 2% by the end of this year, meaning the central bank would be able to cut rates in 2024. Markets took that as a blessing to price in roughly seven quarter-point rate cuts, predicting the fed funds rate would fall as low as roughly 3.6% by the end of this year and 3% by 2025. See the yellow and green lines in the chart. Any forecast for inflation falling steadily toward 2% assumes that goods prices will keep sliding and that services inflation will ease materially from elevated levels. Those outcomes are highly uncertain, we believe. Instead, both goods and services inflation have been hotter than expected – a reality check for the Fed and markets alike. Market pricing of where rates will be by the end of this year and next has jumped in response to such sticky inflation.

On our part, we had expected goods deflation to pull inflation briefly toward 2%, before stubborn services inflation moved it back further above target in 2025. Our view on inflation’s destination likely holds. But the ramp-up in goods prices suggests it will be difficult to achieve even a near-term dip. The Fed is now accepting rates need to stay high for longer given sticky inflation. It also pushed back against hikes. Yet greater macro volatility makes it harder for both markets and policymakers to predict what’s ahead. That’s why we rely on new data, instead of Fed policy signals, to shape our view of the likely policy path.

Earnings keeping stocks afloat

Higher interest rates usually hurt U.S. stock valuations. Instead, strong Q1 earnings have supported stocks even as high rates and lofty expectations raise the bar for what can keep markets sanguine. Some 77% of S&P 500 firms reporting have beat the consensus, LSEG data show. Tech stocks and artificial intelligence beneficiaries have kept up their robust growth, while other sectors also see recoveries. Given volatile data and policy uncertainty, we think long-term U.S. Treasury yields can swing in either direction for now and stay neutral on a six- to 12-month tactical horizon. In the longer run, we think long-term yields will climb as investors demand more term premium, or compensation for the risk of holding bonds. With the U.S. Treasury boosting borrowing, we see rising debt leading to term premium’s return.

High-for-longer U.S. interest rates have implications globally, like in Japan, where the yen has slid to 34-year lows against the dollar. Suspected efforts by Japanese authorities to buy dollars may slow the slide, but the divergence between Bank of Japan and Fed policy is the source of yen weakness. Yet the European Central Bank may be able to cut rates even if the Fed keeps policy tight for longer. Europe’s inflation is cooling further toward 2% and economic activity has been weak since 2022, even with a surprise bump in Q1 GDP. The muted growth and weak earnings backdrop keeps us underweight European stocks.

Our bottom line

We see interest rates staying high for longer and keep eyeing incoming data. We remain tactically overweight U.S. stocks due to support from earnings and neutral long-term bonds given ongoing yield volatility. Professional investors can visit our Capital market assumptions page to learn more about our long-run view on developed market long-term bonds.

Market backdrop

The S&P 500 rose slightly last week and is up about 8% this year thanks to corporate earnings topping high expectations. U.S. 10-year Treasury yields dropped to around 4.50%, about 25 basis points below their 2024 high hit in late April, after U.S. payrolls undershot expectations and the Fed said its next move was unlikely to be a hike. Yet last week’s Fed meeting also confirmed we’re in a structurally higher interest rate environment.

We expect the BOE to hold rates steady this week. Markets have pared back their expectations of rate cuts this year due to slowly falling inflation. We watch UK GDP data out this week for signs growth momentum is starting to pick up from a period of stagnation. U.S. consumer sentiment data and data on China’s services sector, trade activity and domestic credit lending are also due for release.

Week Ahead

May 6: China Caixin services PMI

May 9: Bank of England (BOE) policy decision; China trade data

May 10: University of Michigan consumer sentiment survey; UK GDP data

May 10-17: China total social financing

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 6th May, 2024 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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BlackRock Commentary: Staying dynamic in our strategic views

BlackRock anticipates that the new macroeconomic environment, characterized by increased volatility, will lead to more frequent valuation changes across asset classes. While short-term outcomes may not always be influenced by valuations, they remain significant in the long run.

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