Day: 8 February 2022

Jean Boivin, Head of the BlackRock Investment Institute together with Wei Li, Global Chief Investment Strategist, Alex Brazier, Deputy Head and Elga Bartsch, head of 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.

Central banks are giving ever more hawkish signals to appear to be responsive to surging inflation. Normalizing policy rates to pre-pandemic levels makes sense to us, as the powerful economic restart does not need stimulus. Markets are betting they will raise rates well beyond that. We disagree, as such policies wouldn’t contain inflation without a heavy toll on growth. This is why we believe central banks will live with inflation for years to come as the world shifts to decarbonize.

Sources: BlackRock Investment Institute, with data from Refinitiv Datastream, 4 Feb. 2022. Notes: The chart shows the pricing of expected central bank policy rates via forward overnight index swaps. The rate shown is the one-year OIS rate expected starting one year from now.

 

Inflation keeps surprising to the upside, and central banks are quickly pulling back emergency stimulus. The European Central Bank (ECB) last week suggested an early end to asset purchases that have underpinned European bond markets. The Bank of England (BoE) again raised rates, and nearly half of its policymakers wanted a bigger rise. Clearly, this is a big deal. Yet markets are ratcheting up expectations of future rate hikes ever higher, as the chart shows. Even the easing stalwart ECB is now expected to raise rates above zero this year (the yellow line).  Market expectations may go higher yet, but we think they are already overdone:  Fewer rate hikes will actually be delivered. We believe central banks are talking tough but ultimately will acknowledge that fighting inflation by aggressively hiking will come at too high a cost to growth. Why? Today’s inflation is driven by supply bottlenecks, energy mismatches and resources reallocation. This is why we see the eventual policy response as muted–but brace for bouts of volatility.

We trimmed risk heading into 2022 because we thought confusion over the macro backdrop could stress markets. The confusion now is stemming from central banks, in our view. Many are opportunistically framing policy normalization to pre-pandemic levels as “fighting inflation.” Normalization is prudent, in our view, but justifying it as fighting supply-driven inflation is not. This is not a typical recovery, with a surge in demand overheating the economy, but a world shaped by supply where growth is still below potential. Central banks already have accepted more inflation, and we see this continuing given the costs of pushing it down. The problem: The tough talk may open a Pandora’s box of risks. Central banks may undermine their credibility. Markets could keep pricing in ever more rate rises, increasing the risk of market stresses. Yield spreads between peripheral European bonds and German bunds already widened significantly last week. All this translates into more volatility for now – even as we believe the eventual policy response to inflation will be historically muted.

Tough policy choices and bouts of market volatility are here to stay, we believe. Why? We expect the transition to reach net-zero carbon emissions by 2050 to transform the macro environment. Will it hurt growth or be inflationary? Compared with the past, yes. But we believe the rear-view mirror is irrelevant for what’s ahead. Climate change is here. An orderly transition should boost growth and mitigate inflation versus no climate action or an eventual rush to decarbonize, in our view. Energy prices are a key part of the supply-driven inflation story. Overall production costs will likely rise as the world shifts away from carbon-intensive energy sources. We see this happening whether the shift is prompted by carbon taxes, regulations or consumers simply choosing to pay more to avoid climate damages. The transition’s resource re-allocation will add to inflation, in our view, as demand and supply shift across companies and sectors. Understanding how the net-zero journey will unfold has never been more important. See Managing the net-zero transition. 

Our bottom line: Many central bankers want to be seen as doing something about inflation, if only for fear of being seen out of touch. Markets are egging them on by pricing in ever more hawkish policy moves. Our compass: It’s not about what central banks say; it’s about what they will have to do. Central banks eventually will be forced to live with inflation, we believe, given the macro backdrop. We are underweight developed market government bonds as we see investors increasingly demanding higher compensation for the risk of holding government bonds. We keep our modest overweight on equities because of the still-low sum total of expected policy rate hikes, but are bracing for bouts of volatility along the way. We see this creating opportunities for those with long investment horizons after a tough start for risk assets this year.

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 February 3, 2022. 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: spot Brent crude, ICE U.S. Dollar Index (DXY), spot gold, MSCI Emerging Markets Index, MSCI Europe Index, Refinitiv Datastream 10-year benchmark government bond index (U.S., Germany and Italy), Bank of America Merrill Lynch Global High Yield Index, J.P. Morgan EMBI Index, Bank of America Merrill Lynch Global Broad Corporate Index and MSCI USA Index.

Bond yields jumped around the globe amid hawkish policy signals and strong economic data. The ECB suggested it would wrap up its asset purchases earlier than expected and declined to rule out a rate increase this year after euro area inflation rose to a record 5.1%. The BoE raised rates again, and the latest U.S. jobs trends were much stronger than expected. What’s key: The cumulative pricing for rate hikes hasn’t changed and is a historically muted response to higher inflation.

Week Ahead

• Feb. 7  – China Caixin Services PMI
• Feb. 10 – U.S CPI inflation
• Feb. 10 – China total social financing
• Feb. 11 – U.S. University of Michigan sentiment: UK preliminary GDP

U.S. CPI data are in focus this week as markets are increasingly pricing in faster and more aggressive Fed rate hikes amid 40-year high inflation. The problem: This is a unique restart that will quickly slow down on its own. Inflation is driven by supply constraints following a huge shift to goods demand, not an overheating economy. So the old policy playbook of aggressively raising rates won’t work, in our view. We still see a historically low sum total of rate hikes supporting stocks.

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 February 7th, 2022 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.

MeDirect Disclaimers:

This information has been accurately reproduced, as received from  BlackRock Investment Management (UK) Limited. No information has been omitted which would render the reproduced information inaccurate or misleading. This information is being distributed by MeDirect Bank (Malta) plc to its customers. The information contained in this document is for general information purposes only and is not intended to provide legal or other professional advice nor does it commit MeDirect Bank (Malta) plc to any obligation whatsoever. The information available in this document is not intended to be a suggestion, recommendation or solicitation to buy, hold or sell, any securities and is not guaranteed as to accuracy or completeness.

The financial instruments discussed in the document may not be suitable for all investors and investors must make their own informed decisions and seek their own advice regarding the appropriateness of investing in financial instruments or implementing strategies discussed herein.

If you invest in this product you may lose some or all of the money you invest. The value of your investment may go down as well as up. A commission or sales fee may be charged at the time of the initial purchase for an investment. Any income you get from this investment may go down as well as up. This product may be affected by changes in currency exchange rate movements thereby affecting your investment return therefrom. The performance figures quoted refer to the past and past performance is not a guarantee of future performance or a reliable guide to future performance. Any decision to invest in a mutual fund should always be based upon the details contained in the Prospectus and Key Investor Information Document (KIID), which may be obtained from MeDirect Bank (Malta) plc.

Franklin Templeton’s Notes from the Trading Desk offers a weekly overview of what our professional traders and analysts are watching in the markets. The European desk is manned by eight professionals based in Edinburgh, Scotland, with an average of 15 years of experience whose job it is to monitor the markets around the world. Their views are theirs alone and are not intended to be construed as investment advice.

The Digest

Whilst there was no real change to overall market themes last week, there were a few developments for investors to be very mindful of. The Bank of England (BoE) and, surprisingly, the European Central Bank (ECB), added to the recently more hawkish rhetoric from the Federal Reserve (Fed). Those comments weighed on equities with the STOXX Europe 600 Index closing down 0.7%. Bond yields in Europe also gapped higher on the back of the announcements. US equity markets did manage to finish higher last week, with corporate earnings taking centre stage there. The S&P 500 Index closed the week up 1.5%. Meanwhile, it was quiet over in Asia with a number of market closed for the Chinese New Year. The MSCI Asia Pacific Index did manage to close up 2.8% on reduced volume.

BoE Rate Hike and an ECB hawkish surprise

Last Thursday, we got the interest rate decision from the BoE, and the UK central bank raised rates by 25 basis points (bps) to 50 bps, which was pretty much in line with market expectations. This marked the first back-to-back hikes for the BoE since 2004, and notably, four out of the nine committee members voted for a 50 bps hike to 75 bps, which was viewed as a hawkish signal. As a result of this rate rise, UK Sterling began to climb whilst government bond yields pushed higher.

With regards to other changes from the BoE announcement, the committee unanimously voted to start shrinking the bank’s balance sheet immediately by no longer reinvesting the proceeds of Gilts, allowing more than £200 billion to run off by 2025. Note, the bank’s balance sheet currently stands at £895 billion. Also, the bank announced it would be offloading its entire stock of corporate bonds by the end of 2023, totalling £20 billion. It also raised its forecast for peak inflation to 7.25% in April vs. the previous forecast of 6%.

Interestingly, during the press conference following the announcement, Governor Andrew Bailey came across as somewhat dovish, saying that it is a mistake to assume BoE rates are on an inevitable long march up. This seemed contradictory to the message the bank was sending with the actual rate increase, which meant that the initial spike in bank stocks were short-lived. However, investors did look through Bailey’s comments into the end of the week and the banks steadied to close the week generally higher.

Money markets are now pricing in an implied rate hike of 39 bps in March and up through 1% in May, despite Governor Bailey’s comments last Thursday that he favoured moving interest rates gradually instead of delivering an unexpected shock to get inflation under control.

The ECB also announced shortly after the BoE. There was speculation prior to the policy meeting as to whether ECB President Christine Lagarde would stick to her dovish stance, despite a surge in inflation data, or whether she’d reverse engines and endorse market rate-hike expectations. The Eurozone Consumer Prices Index (CPI) number last Thursday came in at a record 5.1%.

Ultimately, the ECB left the main refinancing rate unchanged at -0.5%, upholding the December policy decision. There were no changes to the Pandemic Emergency Purchase Programme or Asset Purchase Programme. However, in the press conference, Lagarde did not stick by her December statement that the ECB would be very unlikely to raise rates in 2022 although she acknowledged that the risks to the inflation outlook were tilted to the upside. This was a new statement which the markets took as hawkish. Lagarde also refrained twice from repeating her December view that interest rates will not be raised in 2022. She did note, however, that any more advanced discussions are being left until the March meeting, when the central bank will have the benefit of having the economic projections. Importantly, Lagarde did note that the ECB will observe the sequencing (i.e,. asset purchases should end first) and that this process will be gradual.

Money markets are now pricing in about 50 bps of tightening for December, suggesting the deposit rate will be lifted to zero from -0.5% at present.

In the United States, Fedspeak and macro data did nothing to dissuade the market of the possibility of a 50 bps rate hike in March. Atlanta Fed Chief Raphael Bostic told the Financial Times that the Federal Open Market Committee (FOMC) could raise by 50 bps in March if needed to tame inflation but did not alter his own calls for three 25 bps hikes this year. Kansas City Fed President Esther George said she would prefer the Fed to be more aggressive in shrinking its balance sheet. In addition, the January US employment report, released on Friday, was also hawkish. Nonfarm payrolls came in at 467,000, which was higher than anticipated.  Also, the December reading was revised upward to 510,000, which some observers think raises the possibility of a 50 bps rate hike in March. Money markets are currently predicting that fed funds rate will breach the 1% mark in July this year, potentially even getting up to 1.5% by December.

Signs of stress in European credit

European government bond yields gapped higher on the back of the central bank announcements. The hawkish rhetoric drove selling in the credit market. The German 10-year bund yield was up 25 bps and returned to positive territory for the first time since May 2019. The Italian 10-year was up 39.4 bps and the equivalent French government bond was up 27.7 bps. In the United States, the 10-year Treasury yield popped 13.9 bps. Also, it is worth noting that the US three-year note is currently yielding about the same as the S&P 500 and the five-year note is comfortably exceeding the S&P Dividend Yield. Also, the market value of negative yielding debt fell by 50% in the last week.

European credit default swaps had been widening through January, but the ECB announcement on Thursday saw an aggressive move wider. This is key to monitor going forward, particularly as the ECB winds down many of its pandemic support programmes in March. The central bank had been seen as a backstop buyer for credit issuance due to the pandemic purchasing programme, so nerves are growing in the credit space for the landscape as we progress through the first quarter.

Week in Review

Europe

European equities sold off once again on Friday to close the week lower, with the STOXX Europe 600 Index down 0.7%. It’s been three months since we had a Friday where European stock markets closed up on the day. Central bank announcements were the key focus last Thursday, with both the ECB and the BoE announcing their interest rate decisions. Corporate earnings have also been a clear focus for investors over the last few weeks; thus far, 24% of European companies expected to report have done so. Of the STOXX 600 companies reporting, 69% have beaten on earnings per share (EPS) estimates, and revenue has likewise exceeded analysts’ expectations.

Volatility remains high within European stock markets and sector performance divergence was notable again last week. Looking at sectors, banks outperformed on the week, helped by the higher interest-rate environment as macro-driven buyers continue to buy the sector. Oil and gas stocks had another strong showing last week, with oil prices creeping up towards US$100 per barrel. At the other end, retail stocks really struggled last week amid weak European retail sales data, and chemical stocks were also lower as a group, given their highly cyclical nature. Automobiles were also particularly weak last Friday following some disappointing earnings and negative corporate headlines in the space. Despite the volatility, inflows into European equities were significant last week.

On the geopolitical front, there was no significant change last week in the Russia-Ukraine situation. The United States gave the green light to move more troops to Europe and dispatch soldiers already stationed on the continent further east, seeking to send a stronger military message, alongside diplomatic efforts. Russia immediately responded by saying that this move is “destructive”. Various discussions continue with US President Joe Biden and French President Emmanuel Macron, who spoke last Wednesday night about Russia’s military buildup and “affirmed their support for Ukraine’s sovereignty and territorial integrity”. Although China hasn’t recognised Russia President Vladimir Putin’s 2014 annexation of Crimea and has urged all sides to show restraint in the present crisis over Ukraine, Foreign Minister Wang Yi told US Secretary of State Antony Blinken in a phone call last week that Russia’s “legitimate security concerns should be taken seriously and addressed”. It is worth noting that the Russian equity market has been steady and is up about 10% from its recent lows.

United States

US equities recovered further ground last week, with the S&P 500 Index up 1.5%, the Nasdaq up 1.6% and the Russell 2000 Index up 1.7%. The week was not without drama though.  Corporate earnings created some memorable moves and last Friday’s better-than-expected January nonfarm payrolls data was also a key talking point. It is worth noting that the S& P500 Index recovered back up above a key psychological level, its 200-day moving average.

Corporate earnings took centre stage last week as a number of technology heavyweights reported. Last Thursday, Meta Platforms (Facebook) closed down 26% post-earnings release. With that, it lost US$251 billion in market cap, marking the most market cap lost by a single security on a single day in the history of the stock market. The following day Amazon traded up 13.5%, and this move marks the most market cap gained (US $191 billion) by a single security on a single day in the history of the stock market.

Energy markets remain a focus with West Texas Intermediate crude oil up6.3% last week, extending its run to a seventh straight weekly gain, and logged its highest close since September 2014 as the US winter storm hit production and helped drive demand. There was also an OPEC+ meeting last week, where, as expected, they agreed to raise production by 400,000 barrels per day in March. With that move in crude oil, it was not surprising to see energy the strongest sector last week. Communication services was the worst-performing space as Meta weighed on the sector.

In terms of macro data, the main event was Friday’s January employment report, which was stronger than expected. Jobs added came in at 467,000 and the prior month’s data saw a significant upward revision to 510,000 jobs added (from 199,000 initially reported). Biden said this data demonstrated “America’s job machine is stronger than ever”.

Despite the recent recovery in equities, it is interesting to see the CNN Fear & Greed index still comfortably in “Fear” territory, suggesting nerves remain over the outlook for equities.

Looking ahead, the CPI inflation data this Thursday will be in focus, along with corporate earnings reports, including Disney, Twitter, Peloton, and Uber.

Asia-Pacific

It was a quiet week in Asia with the Chinese Lunar New Year holiday shutting mainland China’s markets all week, with Hong Kong only open for a half day on Monday. That being said, the overall region had a decent move up 2.76%, albeit on reduced volumes.

For the markets that were open last week, Japan had a decent week, up 2.7% on the back of press speculation that the government is going to ease the ban on foreigners into Japan, together with reassuring comments from the Bank of Japan saying that it had no plans to modify its supportive policy.

Australia’s benchmark index closed the week up 1.89% as the Reserve Bank of Australia (RBA) exited from its quantitative easing (QE) policies, although policymakers emphasised that this did not mean that rate hikes were imminent.

In South Korea, core inflation accelerated further to 3.0%, keeping pressure on the Bank of Korea to further hike rates at its 24 February meeting as it battles to keep price rises to its 2% target. After suffering heavy outflows in the last two weeks of January, foreign buyers returned to South Korea’s market when the market reopened on Thursday, and it managed to close the week up 3.26%.

China’s equity markets closed higher today after reopening from the holiday break, mainly catching up after Hong Kong’s strong performance on Friday.

The Week Ahead

Key Events:

Monday 7 February: Germany Industrial Production (IP)

Thursday 10 February: US Jobless claims and CPI

Friday 11 February: UK gross domestic product (GDP) and trade balance

Calendar:

Monday 7 February:

• Germany IP (fell 4.1% vs expectation of -3.6%)
• US consumer credit
• China composite and services Purchasing Managers’ Index (PMI) (51.4 vs 50.5 exp)

Tuesday 8 February:

• France trade and current account (CA) balance
• Spain industrial output
• US trade balance

Wednesday 9 February:        

• Italy IP
• Germany trade and CA balance
• Japan machine tool orders

Thursday 10 February:

• US jobless claims and CPI
• China money supply

Friday 11 February:

• UK GDP and trade balance
• Germany CPI

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All investments involve risks, including the possible loss of principal. The value of investments can go down as well as up, and investors may not get back the full amount invested.  Stock prices fluctuate, sometimes rapidly and dramatically, due to factors affecting individual companies, particular industries or sectors, or general market conditions. Bond prices generally move in the opposite direction of interest rates. Thus, as prices of bonds in an investment portfolio adjust to a rise in interest rates, the value of the portfolio may decline. Investments in foreign securities involve special risks including currency fluctuations, economic instability and political developments. Investments in developing markets involve heightened risks related to the same factors, in addition to those associated with their relatively small size and lesser liquidity.

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Past performance is not an indicator or guarantee of future performance. There is no assurance that any estimate, forecast or projection will be realised.

This article reflects the analysis and opinions of Franklin Templeton’s European Trading Desk as of 7 February 2022, and may vary from the analysis and opinions of other investment teams, platforms, portfolio managers or strategies at Franklin Templeton. Because market and economic conditions are often subject to rapid change, the analysis and opinions provided may change without notice. An assessment of a particular country, market, region, security, investment or strategy is not intended as an investment recommendation, nor does it constitute investment advice. Statements of fact are from sources considered reliable, but no representation or warranty is made as to their completeness or accuracy. This article does not provide a complete analysis of every material fact regarding any country, region, market, industry or security. Nothing in this document may be relied upon as investment advice or an investment recommendation. The companies named herein are used solely for illustrative purposes; any investment may or may not be currently held by any portfolio advised by Franklin Templeton. Data from third-party sources may have been used in the preparation of this material and Franklin Templeton (“FT”) has not independently verified, validated or audited such data. FT accepts no liability whatsoever for any loss arising from use of this information and reliance upon the comments, opinions and analyses in the material is at the sole discretion of the user. Products, services and information may not be available in all jurisdictions and are offered by FT affiliates and/or their distributors as local laws and regulations permit. Please consult your own professional adviser for further information on availability of products and services in your jurisdiction. 

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MeDirect Disclaimers:

This information has been accurately reproduced, as received from Franklin Templeton Investment Management Limited (FTIML). No information has been omitted which would render the reproduced information inaccurate or misleading. This information is being distributed by MeDirect Bank (Malta) plc to its customers. The information contained in this document is for general information purposes only and is not intended to provide legal or other professional advice nor does it commit MeDirect Bank (Malta) plc to any obligation whatsoever. The information available in this document is not intended to be a suggestion, recommendation or solicitation to buy, hold or sell, any securities and is not guaranteed as to accuracy or completeness.

The financial instruments discussed in the document may not be suitable for all investors and investors must make their own informed decisions and seek their own advice regarding the appropriateness of investing in financial instruments or implementing strategies discussed herein.

If you invest in this product you may lose some or all of the money you invest. The value of your investment may go down as well as up. A commission or sales fee may be charged at the time of the initial purchase for an investment. Any income you get from this investment may go down as well as up. This product may be affected by changes in currency exchange rate movements thereby affecting your investment return therefrom. The performance figures quoted refer to the past and past performance is not a guarantee of future performance or a reliable guide to future performance. Any decision to invest in a mutual fund should always be based upon the details contained in the Prospectus and Key Investor Information Document (KIID), which may be obtained from MeDirect Bank (Malta) plc.