Wei Li, Global Chief Investment Strategist together with Alex Brazier, Deputy Head, Yu Song, Chief China Economist, Paolo Puggioni, Data and Innovation Manager and Michel Dilmanian, Member of Investment Strategy team, 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.
The new year has started with a record COVID surge, renewed restrictions and many people working from home again. The difference with this time: The Omicron strain appears less severe in populations with high vaccination and immunity rates. We see Omicron delaying – and not derailing - the powerful restart of economic activity while potentially adding to supply bottlenecks. We stay overweight equities and eye risks that policymakers or markets misread the current surge in inflation.
Markets have started the new year on a jittery note, with worries centering on Fed rate rises and policy normalization. We urged investors to stay invested through COVID-related volatility as we believed the strain would ultimately only delay the powerful restart of economic activity that has underpinned a surge in corporate profits. More clarity on Omicron in the past weeks has strengthened our conviction, even as the COVID surge may look frightening. Why? First, vaccines and prior infections have proven effective against severe disease even as their efficacy against Omicron infection has fallen. Second, scientific studies are suggesting Omicron is intrinsically somewhat less severe than previous strains. Third, populations have gained higher immunity as more people have caught COVID or received boosters. All this suggests a surge in cases but a more muted rise in hospitalizations. We view the situation in the recent Omicron hot spot of London as a harbinger of things to come. Case loads spiraled upward to almost double the previous peak in early 2021 (the red line in the chart). Yet hospital admissions have remained 50% below the earlier highwater mark (the yellow line).
Both case loads and hospitalizations in London have started to come down, suggesting the worst of the Omicron wave may be over. We expect other areas to follow a similar pattern over the next couple of months. The caveats: Outcomes will likely be worse elsewhere as the UK sports high vaccination, booster and immunity rates. And pressure on hospitals and services in general is set to mount as they already face staff shortages. Check out our COVID-19 tracker for the latest trends.
The key question is how China’s zero-COVID policy will stand up against Omicron. The policy so far has proven effective and enjoyed popular support, but has left China with almost no natural immunity. We expect the country to maintain the policy – at least optically – in this politically important year. This raises the spectre of more restrictions on activity, from targeted measures that keep the economy humming (Shanghai) to full-scale lockdowns (Xi’an). As a result, we believe downside risks to China’s growth have risen, even as Beijing appears bent on achieving its growth target this year by loosening policy. The big picture on Omicron remains that we see it only delay the powerful global restart. Less growth now means more growth later, in our view. Omicron also may have a silver lining. Its highly infectious nature may turn COVID into an endemic disease similar to the flu as populations build up immunity and annual booster shots keep down the human toll.
Risk assets showed clear concern about the Fed over Omicron last week. Policymakers and markets may misread the unique mix of the restart, a mutating virus, supply-driven inflation and new central bank policies. Our base case: Central banks take their foot off the gas pedal to move away from emergency stimulus. We expect them to live with inflation, rather than hit the brakes by raising rates to restrictive levels. The Fed has signaled three rate rises this year – more than we expected. Markets seem primed to equate higher rates as being negative for equities. We’ve seen this before and don’t agree. What really matters is that the Fed has kept signaling a low sum total of rate hikes, and that didn’t change last week. This historically muted response to inflation should keep real policy rates low, in our view, supporting equities. And not all spikes in long-term yields are the same. Last week’s jump in U.S. Treasury yields was about the Fed signaling a readiness to start shrinking its balance sheet. This could result in a return of term premium that typically demand to hold long-term bonds. But this is not necessarily negative for risk assets but can reflect an investor preference for equities over government bonds. Our bottom line: We prefer equities and would use COVID-related selloffs to add to risk. We are underweight DM government bonds – we see yields gradually heading higher but staying historically low.
Stocks and bonds fell after minutes from the Fed’s December meeting indicated a potentially faster-than-expected policy normalization, including speeding up the timeline for trimming its bond portfolio. The big picture remains that major central banks have indicated a historically muted response to rising inflation. This should keep real yields negative and support equities. We see inflation settling at a level higher than pre-COVID even as pressures from supply bottlenecks ease.
Investors will get a read on the persistence of U.S. consumer price inflation this week, while Chinese credit data may provide clues on the speed of policy loosening. The powerful economic restart has driven U.S. inflation rates to its highest rate in decades. This means the Federal Reserve has clearly met its average inflation target under its new framework, helping open the door for interest rate rises this year.
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