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BlackRock Commentary: Policy revolution – What’s Next?

Jean Boivin, Head of the BlackRock Investment Institute together with Mike Pyle, Global Chief Investment Strategist, and Elsa Bartsch, Head of Macro Research, also 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.

Macroeconomic policy has gone through a needed revolution to cushion the coronavirus shock. It essentially aims to “go direct” and is blurring fiscal and monetary policies. Yet this policy shift has opened the door to unprecedented government intervention in markets and companies, and we see it as a slippery slope – unless it comes with proper guardrails and a clear exit strategy.

Blackrock 08.06.2020 Image 1

Sources: BlackRock Investment Institute, with data from the Federal Reserve, European Central Bank, Bank of Japan, Bank of England, and Haver Analytics, June 2020. Notes: We use estimated targets for the total size of the U.S. and euro area corporate purchases and lending schemes for 2020. For the euro area we include TLTRO funding, and for the UK we include central bank support for the TFS bank lending scheme. The euro area numbers are averages of the four largest economies in the bloc, Germany, France, Italy and Spain.

The scale and speed of the policy response has been greater than at any moment in peacetime history, fundamentally transforming the core tenets of global policy frameworks and financial markets. We view the economic impact and policy response as two key signposts for gauging the virus shock, and compare our assessment of the lost national income across major economies with policy measures announced to date. The orange bars show the full-year hit to GDP from our sector-level bottom-up analysis, including the initial impact on the most affected sectors (such as travel and leisure) and the broader impact on the whole economy due to spillover effects (light orange). The fiscal response more than covers the initial impact in the U.S. Once we factor in the spillover to the full economy, the fiscal policy response (dark yellow) globally falls short. Yet the situation improves when monetary policies (light yellow) are accounted for. This is especially striking in the U.S., as the chart shows.

Major economies may still struggle to entirely bridge the gap left by the plunge in demand, income and cash flow, despite the unprecedented policy measures, in our view. We see a risk of policy fatigue leading to an exit or a retrenchment too soon, especially in the U.S. The U.S. labor market unexpectedly improved in May, showing signs that policy interventions were cushioning the blow from the shock – and highlighting the risk that policymakers may give up on relief measures sooner than necessary.

The uncharted territory that policymakers have entered makes policy execution particularly important. The new policies explicitly attempt to “go direct” – bypassing financial sector transmission and delivering liquidity to individuals and businesses. Another aspect of this policy revolution is the explicit blurring of fiscal and monetary policies, including central banks absorbing new government debt to maintain low bond yields. In addition, some government support comes with strings attached, including conditions around dividend payouts and share buybacks.

We wrote about the necessity for monetary and fiscal coordination to deal with the next downturn last August. Effective coordination would reduce lost output in a major shock, and could lessen other risks, such as rising inequality, that were seen as arising from the unbalanced policy response to the financial crisis. We warned it needed proper guardrails and a clear exit strategy to mitigate a risk of uncontrolled deficit spending with commensurate monetary expansion and, ultimately, inflation. One approach we laid out is a Standing Emergency Financing Facility (SEFF), a framework in which the exit from the joint monetary-fiscal policy effort is explicitly determined by the inflation outlook. To be credible, this exit decision must be independently controlled by the central bank. And even a well-designed monetary strategy may not prevent a change toward a higher inflation regime in the medium term because of deglobalization and re-regulation trends.

The bottom line: The policy revolution is a near-term positive for markets but, in the absence of guardrails, might not be in the medium term. One key investment implication is the reduced ballast properties of nominal government bonds over a strategic horizon, as interest rates are near or at their effective lower bounds and we see greater inflation risks in coming years. We think increased strategic allocations to inflation-linked bonds are sensible amid this shifting balance of risk.

Market Updates

Blackrock 08.06.2020 Image 2

Past performance is not a reliable indicator of current or future results. It is not possible to invest directly in an index. Sources: BlackRock Investment Institute, with data from Refinitiv Datastream, June 2020. Notes: The two ends of the bars show the lowest and highest returns versus the end of 2019, and the dots represent 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, MSCI USA Index, the ICE U.S. Dollar Index (DXY), MSCI Europe Index, Bank of America Merrill Lynch Global Broad Corporate Index, Bank of America Merrill Lynch Global High Yield Index, Datastream 10-year benchmark government bond (U.S. , German and Italy), MSCI Emerging Markets Index, spot gold and J.P. Morgan EMBI index.

 

Market backdrop

Measures to contain the virus are gradually being eased in many developed economies. May’s data suggested the worst of the contraction may be behind us, but we see a bumpy restart in coming months. The big question remains: how successful policy execution will be in bridging cash flow constraints and preventing permanent damages to the economy – and what the risk is of policy fatigue in coming months. Markets became wary of rising U.S. China tensions.

Week Ahead

  • Wednesday: China consumer price index and producer price index; Federal Reserve policy meeting.
  • Friday: University of Michigan Survey of Consumers June preliminary.

The Fed’s policy meeting and the preliminary release of the University of Michigan Sentiment for June will be the focus this week. The Fed is expected to reiterate the whatever-it-takes approach, and keep its interest rate guidance unchanged. Its Summary of Economic Projections is likely to describe a slow economic rebound. The University of Michigan survey will show where consumer sentiment stood after U.S. consumers cut spending by the most on record for two straight months.


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 June 8th, 2020 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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