Wei Li, Global Chief Investment Strategist, BlackRock Investment Institute together with Elga Bartsch, Head of Macro Research, and Kurt Reiman, Senior Strategist for North America, 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.
We still see a low risk of technical default by the U.S. and expect the debt ceiling debacle to ultimately resolve. The broadening economic restart keeps us tactically pro-risk, yet we see a narrowing path for risk assets to push higher and markets more prone to temporary pullbacks. Key events toward the year end, including the lapse of the temporary debt ceiling rise, could potentially trigger market volatility. We favor looking through market jitters against the backdrop of the restart.
Sources: BlackRock Investment Institute, with data from Google, October 2021. Notes: Interest over time shows search interest relative to the highest point on the chart for the given time, according to Google. A value of 100 is the peak popularity for the term. A value of 50 means that the term is half as popular. A score of zero means there was not enough data for this term.
The showdown around the debt ceiling – a self-imposed federal borrowing limit – has kept investors on their toes. The debt ceiling has become a subject of intense partisan wrangling over recent decades, with negotiations going down the wire in 2011 and 2013. Google searches on the key phrase “debt ceiling” have surged to the highest level since the 2013. See the chart above. In recent months the impasse has led to market jitters, especially after risk assets have had an extended run higher. The front end of Treasury yield curve – a popular gauge of market sentiment on the issue – had shot up until the Senate struck a deal to temporarily raise the debt ceiling last week. Yet there is more political squabble to come toward the year end. The U.S. government could once again near a technical default around the time when the temporary government funding is set to lapse if Congress fails to approve new spending legislation and raise the debt ceiling. Democrats have yet to unify behind their multi-trillion-dollar spending plans on infrastructure, social policy and climate change.
The temporary debt ceiling increase will likely allow the Democratic Party to focus on rallying its members in Congress around the spending plans – key legislative priorities ahead of the 2022 midterm elections. As expected, the $3.5 trillion price tag of the bill on social policy and climate change is being scaled down to help ensure the support of party moderates.
A smaller package means a reduced amount of revenue needed to offset spending. The tax proposals from the House Ways and Means Committee prior to the latest effort among Democrats to scale down the plan already showed moderated tax increases. This includes a proposed rise in the corporate tax rate to 26.5%, down from 28% in the original proposal. It also showed an increase in the Global Intangible Low Tax Income (GILTI) tax – intended to discourage corporations from moving profits overseas – to 16.5%, down from 21%. This increase would be line with the new global minimum tax agreement that aims to achieve the same goal. We are tactically neutral U.S. equities as we see large caps as exposed to risks of higher taxes and tighter regulation. The tax increases will likely have the largest impact on financials and communication services, in our view, but any further watering down of the proposed tax increases would reduce the headwind for these sectors.
The debt ceiling debate recently has triggered headlines and volatility, and we believe markets generally are increasingly susceptible to swings in sentiment. This includes supply-driven price spikes in energy and other prices awaking fears of runaway inflation and central bank actions to suppress it. We see the price spikes as mostly related to the powerful economic restart and therefore not permanent, but recognize inflation narratives can easily take hold of markets.
The bottom line: We continue to see a low risk of a technical default by the U.S. government, and expect a downsized spending package and related tax increases. The debt ceiling showdown may return in December, yet we believe it will ultimately be resolved and prefer to look through potential market volatility. Political brinkmanship could lead to a short-lived government shutdown and reignite concerns of a technical default. We are tactically neutral U.S. equities as we see U.S. growth momentum peaking and expect other regions to benefit more from the broadening economic restart. We are strongly underweight U.S. Treasuries as we see a gradual rise in nominal yields even with the Fed poised to start tapering by the end of the year. We are tactically pro-risk, yet recognize the path for further gains in risk assets has narrowed after an extended run higher and that markets have become more susceptible to sentiment swings.
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 Oct. 7, 2021. 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, in descending order: spot Brent crude, MSCI USA Index , MSCI Europe Index, ICE U.S. Dollar Index (DXY), Bank of America Merrill Lynch Global High Yield Index, MSCI Emerging Markets Index, Refinitiv Datastream Italy 10-year benchmark government bond index, J.P. Morgan EMBI Index, Bank of America Merrill Lynch Global Broad Corporate Index, Refinitiv Datastream Germany 10-year benchmark government bond index, Refinitiv Datastream U.S. 10-year benchmark government bond index and spot gold.
Market backdrop
U.S. nonfarm payrolls growth slowed sharply in September due to the delta variant surge. U.S. stocks reversed the previous week’s decline after the Senate agreed to temporarily raise the debt ceiling. U.S. 10-year Treasury rose to the highest level since June. We view the recent yield backup as correcting a disconnect between the restart and earlier yield levels, rather than foreshadowing a more drastic yield rise. Stronger-than-expected activity data and more hawkish signals from policymakers have shifted the market consensus on the Bank of England’s interest rate liftoff to the first quarter of 2022.
Week Ahead
- Oct 11-18: China total social financing and new yuan loans
- Oct 13: U.S. consumer price index (CPI)
- Oct 14: U.S. producer price index (PPI); China CPI, PPI
- Oct 15: University of Michigan Surveys of Consumers
U.S. inflation data will be in focus this week. Consumer prices increased at their slowest pace in six months in August as prices of some items related to the Covid shock had subsided, though inflationary pressure had broadened beyond pandemic-related items. Consensus forecast sees a 5.4% annual increase, compared with a 5.3% rise in the previous month, according to Reuters.
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