Jean Boivin, Head of the BlackRock Investment Institute together with Wei Li, Global Chief Investment Strategist, Elga Bartsch, Head of Macro Research and Scott Thiel, Chief Fixed Income Strategist, all 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.
A powerful economic restart is underway in the U.S. – with Europe and emerging markets (EMs) set to follow. At the same time our new nominal theme has been playing out, with a hefty jump in inflation expectations but a more muted rise in nominal yields. Against this backdrop, we reiterate our pro-risk stance and refine our tactical views in response to adjustments in market pricing and valuations.
Forward looking estimates may not come to pass. Sources: BlackRock Investment Institute, Federal Reserve, and Reuters News, with data from Haver Analytics, April 2021. The charts show the level and estimates of U.S. GDP over time for the global financial crisis (GFC) and the Covid-19 shock. Both series are rebased to 100 for the year prior to the shock – 2007 and 2019. Estimates are from the Fed’s Federal Open Markets Committee’s Summary of Economic Projections published through 2008 on the left and 2020-21 on the right. The level of GDP is derived from the FOMC’s forecasts of GDP growth from the fourth quarter of the prior year to the fourth quarter of the current year. Early estimates are as of Jan 2008 for GFC (June 2020 for Covid); later estimates as of Nov. 2008 (Mar. 2021 for Covid).
We are at an uncertain juncture in markets. Investors are grappling with how to interpret unusual growth dynamics and new central bank frameworks. On the first, U.S. activity looks set to restart strongly this year, powered by pent-up demand across income cohorts and sky-high excess savings. Growth forecasts have been catching up, as the chart above shows, but the magnitude of the restart may still be underappreciated. This is in stark contrast to the repeat growth disappointments seen after the global financial crisis – and reflects the different nature of this shock. We see it as more akin to a natural disaster followed by a rapid “restart” – rather than a traditional business cycle recession followed by a “recovery.” This is why a year ago we warned against extrapolating too much from the steep decline in activity. Now the same is true – but in reverse. U.S. growth will likely peak over the summer but the eye-popping data will be transient: the more activity is restarted now, the less there will be to restart later. We see the rest of the world following the U.S. and reopening as vaccine rollouts pick up pace.
The second dynamic investors are grappling with is new central bank frameworks. Our new nominal theme helps us navigate this environment. The Federal Reserve is building credibility in its new framework and has set a high bar to change its easy policy stance, even in face of higher realized inflation. This has yet to be fully digested by markets, in our view. We see markets still underestimating the potential for the Fed to achieve above-target inflation in the medium term as it looks to make up for persistent undershoots in the past. This is why we think the direction of travel for yields is higher. But we believe the overall adjustment will be much more muted than one would have expected in the past based on growth dynamics – and much adjustment has already taken place.
As a result of these two key dynamics, we maintain our pro-risk tactical view. We remain overweight equities, neutral credit and underweight government bonds on a tactical basis. Yet we have tweaked some of our tactical views given significant moves in market pricing. For example, 10-year Treasury yields have more than tripled from last year’s lows around 0.5%. This leaves less room for further rises in yields on a tactical horizon, in our view. U.S. inflation expectations also have come a long way since we moved to an overweight in U.S. Treasury Protected Securities (TIPS) early last year. As a result, we are trimming our tactical underweight to U.S. Treasuries and closing our overweight in TIPS – even as we see room for yields to push higher and inflationary pressures to build further in the medium term. In a world starved for income, we have upgraded EM local currency debt on attractive valuations and the prospect of a stable dollar as the restart broadens, prefer high yield over investment grade credit and see opportunities in private markets. Within equities we express our pro-cyclical stance through overweights to EM and U.S. small caps as beneficiaries of the vaccine-led restart.
Bottom line: The broadening restart – coupled with our belief that this will not translate into significantly higher rates – underpins our pro-risk stance. Risks remain, however, on the tactical horizon. One is a market overreaction to exceptional growth data in the months ahead. We may see bouts of volatility as markets test the Fed’s resolve to stay “behind the curve” on inflation. Any temporary spikes in rates may challenge EM assets in particular, but we advocate staying invested and looking through any turbulence as our “new nominal” plays out. Want to know more? BII’s Global Outlook (GO) meeting on April 27 is a chance to hear from us directly and ask questions. Contact your BlackRock relationship manager for details.
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 April 22, 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, MSCI Emerging Markets Index, the ICE U.S. Dollar Index (DXY), Bank of America Merrill Lynch Global High Yield Index, Refinitiv Datastream Italy 10-year benchmark government bond index,, Refinitiv Datastream Germany 10-year benchmark government bond index, Bank of America Merrill Lynch Global Broad Corporate Index, J.P. Morgan EMBI index, Refinitiv Datastream U.S. 10-year benchmark government bond index and spot gold.
A decline in U.S. Treasury yields and strong corporate earnings are providing some support to equities. Some 87% of S&P 500 companies have beaten estimates for the first quarter, with just under one-fifth having reported, Refinitiv data showed as of Thursday. The five largest S&P 500 companies report this week. The Bank of Canada last week said it would start to taper down its asset purchases, becoming the first major central bank to signal an exit from quantitative easing. This comes ahead of a Federal Reserve policy meeting where the central bank is likely to reiterate its desire to stay “behind the curve.”
- April 27 – Bank of Japan policy decision
- April 28 – U.S. GDP (advance)
- April 29 – U.S. FOMC policy decision; President Biden address to joint session of Congress
- April 30 – Japan and China manufacturing PMIs; euro area preliminary GDP
The FOMC policy meeting will be in focus this week. Our new nominal theme that nominal yields will be less sensitive to expectations for higher inflation was confirmed by the Fed in the last policy meeting, a clear reaffirmation of its commitment to be well “behind the curve” on inflation. Elsewhere, U.S. President Joe Biden is expected to make the case in an address to Congress for a more than $2 trillion infrastructure package as well as accompanying tax reforms that would partly fund it.
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