Day: 22 March 2022

Jean Boivin, Head of the BlackRock Institute together with Wei Li, Global Chief Investment Strategist, Alex Brazier, Deputy Head of he BlackRock Institute and Nicholas Fawcett, Member of the Economic and Markets Research 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.

Key Points:

Fed Rate Hikes – The Fed is talking tough on inflation by projecting a large and rapid increase in rates, but we think it won’t fully deliver and be forced to live with inflation. 

Market backdrop – The S&P 500 scored its biggest weekly gain since 2020, and bond yields rose. Chinese shares rebounded sharply after officials reassured a panicky market.

Week ahead – Economic data this week are likely to show a worsening in economic activity and consumer sentiment due to the Ukraine war and high inflation.

The Fed last week signaled a large and rapid increase in its policy rate over the next two years and struck a surprisingly hawkish tone, indicating it’s ready to go beyond normalizing to try to tame inflation. It’s easy to talk tough, and we believe the Fed is unlikely to fully deliver on its projected rate path. The reason? It would come at too high a cost to growth and employment. We do now see a higher risk of the Fed slamming the brakes on the economy as it may have talked itself into a corner. 

The Federal Reserve has kicked off its hiking cycle with a quarter-point increase – the first since 2018. The decision was expected. What surprised was the Fed’s stated goal to get the fed funds rate to 2.8% by the end of 2023 (see the pink dots on the chart). This level is in the territory of destroying growth and employment, in our view. At the same time, the Fed’s latest economic projections pencil in persistently high inflation but low unemployment – even as it has called current labor conditions tight. We believe this means the Fed either doesn’t realize its rate path’s cost to employment or – more likely – that it shows its true intention: to live with inflation. We think this is necessary to keep unemployment low because inflation is primarily driven by supply constraints and high commodities prices.

BoE provides a glimpse ahead

The Bank of England (BoE), the first major developed market (DM) bank to kick off the current hiking cycle, increased its policy rate for the third time to 0.75%. Like the Fed, the BoE recognized additional inflation pressures from high energy and commodity prices. It also signaled that it may pause further rate increases, with rates back at pre-pandemic levels. We believe this means the BoE is willing to live with energy-driven inflation, recognizing that it’s very costly to bring it down.

The BoE provides a glimpse of what other DM central banks may do once they get back to pre-pandemic rate levels and the effect of rate rises on growth become apparent. The Fed’s tone may change as the consequences for growth become more apparent after aggressively hiking this year. The Fed last week perhaps wanted to appear tough by implying even more rate increases in future years to keep inflation expectations anchored, in our view, without expecting to deliver those hikes. To be sure: The Fed will normalize policy because the economy no longer needs pandemic-induced stimulus. It has also signaled it will start reducing its balance sheet, marking the start of quantitative tightening. Finally, we expect the Fed to raise the fed funds rate to around 2% this year – close to pre-pandemic neutral levels – and then pause to evaluate the effects.

What are the risks? Central banks are in a tough spot. First, they may start to believe some of their own rhetoric – and think they can raise rates well above neutral levels without damaging growth. They could hike too much, too fast as a result – and plunge economies into recession. We think this risk has risen since last week’s Fed meeting. Second, inflation expectations could de-anchor and spiral upward as markets and consumers lose faith that central banks can keep a lid on prices. This could force them to act aggressively amid persistently high inflation.

Our bottom line:

Last week’s central bank actions reinforce our views. We see more pain ahead for long-term government bonds even with the yield jump since the start of the year. We expect investors will demand more compensation for the risk of holding government bonds amid higher inflation. We stick with our underweight to nominal government bonds on both tactical and strategic horizons. We think the hawkish repricing in short-term rates is overdone and prefer short-maturity bonds over long-term ones. We prefer to take risk in equities over credit in the inflationary backdrop because we expect real – or inflation-adjusted – yields to stay historically low. We added to the DM equity overweight two weeks ago. We still like the overweight in this environment but see a differentiated regional impact from higher energy prices.

Market backdrop

Stocks rallied and government bond yields climbed last week after the Fed raised rates and Chinese policymakers soothed beaten-down Chinese markets. Chinese equities rebounded after officials suggested an end to the crackdown on tech companies and announced a relaxation of Covid restrictions to hit growth targets. We believe China’s ties to Russia have created a risk of geopolitical stigma, including potential sanctions.

Early survey data for March are likely to show a sharp worsening in sentiment because of the war in Ukraine and a spike in energy and other prices. We see the war weighing heavily on economic activity – especially in Europe – and pushing up inflation as higher energy prices pass through to consumer prices. We underweight nominal government bonds and prefer developed stocks in this inflationary backdrop.

Week ahead

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 28th, 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

More than anything else, hope led global equity markets higher last week. Headlines were very mixed as to when we would likely see an end to the war in Ukraine, with no progress of any great substance being made. The STOXX Europe 600 Index closed the week up 5.4%, the S&P 500 Index was up 6.1%, whilst the MSCI Asia Pacific Index was up 4.1%. The MSCI All Country Index rebounded to close up 5.7%, which is its biggest weekly gain since November 2020, when the success of the COVID-19 vaccines was first announced. Despite the overall strength last week, stock markets were really at the mercy of the headlines tied to Ukraine, which flip-flopped from one day to the next on the progress of peace talks. Outside of that, some clarity from the Federal Reserve (Fed), a dovish Bank of England (BoE), as well as some more supportive news flow out of Asia aided markets as the week went on.

Central Bank Announcements

Last week, investor focus shifted briefly onto central bank announcements. On Wednesday, the Fed raised interest rates by 25 basis points (bps) and signalled a faster pace of tightening. The “dot plot” chart of the Fed’s projections indicated a faster pace of rate hikes through 2023, shifting significantly higher in the near term—it is now indicating seven 25 bps hikes this year and another four in 2023. With regards to the possibility of a larger 50 bps rate hike, Fed Chair Jerome Powell indicated that if inflation fails to moderate as expected, then the Fed would be prepared to tighten more aggressively. The meeting statement, as well as Powell’s press conference, indicated that balance sheet reduction is likely to begin soon, with a possible announcement coming at the next meeting in May. Powell went on to say that plans are close to being finalised on that, increasing expectations for news at May’s policy meeting.

On Thursday, the BoE raised rates by 25 bps to 75 bps, as expected. The committee voted 8-1 in favour of the 25 bps rise, with the one dissenter voting to keep interest rates on hold. The dissenter, Jon Cunliffe, argued that Russia’s invasion of Ukraine could “increase uncertainty and decrease consumer and business confidence”. The release was viewed as slightly dovish as it also seemed to exclude a 50 bps hike in the near term. The market was braced for a possible 50 bps hike, or at least details or language suggesting one may be coming soon. With regards to events in Ukraine, the minutes stated that “there was little evidence available yet on the impact of the invasion (of Ukraine) on UK economic activity”. This will clearly be an area of focus for future central bank rhetoric in the months to come.

With regards to inflation per se, the minutes state that “further out, inflation was expected to fall back materially, and possibly to a greater extent than had been expected in the February report, as energy prices stopped rising and as the squeeze on real incomes and demand put significant downward pressure on domestically generated inflation”. With that, there is clearly still plenty of room for debate on the push and pull of inflation pressures through 2022.

Investors Hope for Russia/Ukraine Ceasefire

The market was hopeful all week that we may soon see an end to the war in Ukraine. The headlines didn’t quite reflect this sentiment, however, with seemingly very little progress being made by the end of the week. Earlier in the week, hopes were raised as Ukrainian President Volodymyr Zelenskyy stated that peace talks were starting to sound “more realistic, but time is still needed”. Zelenskyy also appeared to concede that Ukraine would not join NATO, one of Russia’s key demands. The Financial Times then reported on Wednesday that a 15-point plan had been drawn up to end the war. The report suggested that “significant progress” had been made with the plan, which included a ceasefire and Russia’s withdrawal if Ukraine declared neutrality and accepted limits on its armed forces. Markets ticked higher on this report. At the same time, oil prices dipped.

However, from then there were a flurry of articles suggesting that progress wasn’t as forthcoming as the article suggested. US Secretary of State Antony Blinken said there were no signs Putin was “prepared to stop” Russia’s invasion. Blinken said Russia’s military actions in Ukraine “are in total contrast to any serious diplomatic effort to end the war”. Also, Ukraine’s Deputy Chief of Staff Ihor Zhovkva said that negotiations had been progressing, but only slowly.

As it stands, around US$470 billion of the Central Bank of Russia’s (CBR’s) US$645 billion in reserves has been frozen. Recall, the bank did an emergency interest-rate hike at the end of February, from 9.5% to 20%, in response to Western sanctions in an attempt to reduce depreciation and inflation risks and support the ruble. On Friday, the CBR kept interest rates at 20%, as expected. Also, it was noted that Putin had asked CBR Governor Elvira Nabiullina to serve another five-year term. She is very well respected outside of Russia. Despite the CBR advising that the latest coupon payments of around US$117 million had been paid, ratings agencies are seeing the risk of default as increasingly likely. With foreign exchange reserves scarce, any default would see Russia’s cost of borrowing increase dramatically in coming years.

Nervousness in Europe

In terms of macro datapoints, it is worth noting that Russia’s invasion of Ukraine is depressing economic recovery hopes in Europe. The German ZEW survey plunged by 93.6 points to -39.3 from 54.3 in February. By comparison, at the beginning of the COVID-19 pandemic in March 2020, the indicator fell by 58.2 points. Other indicators within the survey had notable moves too. The assessment of the current macroeconomic situation worsened to -21.4 in March from -8.1 in February. At the same time, inflation expectations surged to 70.2 in March from -37.5 in February. The survey tends to be volatile, but it’s one to watch out for over the next couple of months.

Week in Review

Europe

European equities were broadly higher last week, with the STOXX Europe 600 Index closing the week up 5.4%. Sector divergence was wide once again in Europe, with some of the recent winners being sold and recent losers finding some relief. With that, financial services, technology and automobile stocks were up on the week. At the other end, we saw profit taking in basic resources and oil and gas stocks, which were both lower last week overall. European credit markets continued to tighten throughout the week and are now close to the levels at the beginning of February/start of March. Friday’s options expiries added liquidity and some volatility into stock markets to end the week. Despite overall market performance, it was another week of outflows for European equity funds.

Some interesting points from the monthly Bank of America Fund Managers Survey, which was released last week. The survey showed some significant shifts in the economic outlook for the region; perhaps not too surprising given recent events. However, it was the largest change in respondents’ outlook on record—a net 69% of respondents expect the European economy to weaken over the coming year, the highest share since 2011. Last month, a net 12% still expected better growth in Europe, with the 81-point swing marking the biggest month-on-month drop on record (going back to 1994).

United States

A strong recovery for US equities last week, with the S&P 500 Index recording its strongest weekly performance since November 2020 (+6.2%). Also, the Dow Jones Industrial Average gained +5.5%, the Nasdaq rose 8.2% and the small-cap Russell 2000 Index was up 5.4%. Volatility declined, with the CBOE VIX index down 22% last week. As discussed, the Fed meeting was a key focus, but sentiment also improved on possible signs of progress in Russia/Ukraine peace talks and as China made constructive comments in regards to stabilising markets. With the move higher, the S&P 500 Index traded back to close around its 200-day moving average, a key technical level.

Looking to sector performance, the best-performing were consumer discretionary and technology, whilst the laggards were utilities and energy. The gains in tech were a key market driver. The NYSE FANG+ Index was up 13.6%, and Chinese ADRs bounced back sharply thanks to the constructive commentary from China (AliBaba +25%, Baidu +25%).

Looking to other asset classes, the selloff in US Treasuries continued, with the 10-year yield up 15.7 bps to 2.15%, and it was notable the US 5- year/10-year curve inverted (first time since March 2020), and the 2-year/10-year spread traded down to the lowest level since February 2020.

US credit markets showed signs of stabilisation on the improved market sentiment, with investment grade credit spreads tightening.

Finally, last week we flagged the CNN Fear & Greed Index was at stretched levels in “Extreme Fear” territory and, with that, there was a risk of a sharp reversal in sentiment and market performance. This proved timely, as it has now swung sharply out of “Extreme Fear” to “Fear” territory as markets recovered ground last week. 

ASIA-Pacific

Last week the market saw a near complete reversal, with the MSCI Asia Pacific Index closing the week up 4.13%, having closed the previous week down 4.06%.

It was a bit of perfect storm at the start of the week, with a sharp rise in COVID-19 cases and implications on demand & supply chains, as well as further worries about a new Sino-Russian relationship and possible sanctions if China was to visibly provide support.

In China, we saw Shenzhen going into lockdown and companies announcing a production halt due to the pandemic in Shenzhen, Shanghai and Jilin. China’s stance on Russia was in focus, amid reports Russia asked Beijing for military equipment and other help. US officials warned Beijing that impeding efforts to punish Russia could have major consequences. Regulatory pressures also weighed on markets, amid fears Chinese firms will be delisted in the United States.

On Tuesday, we did see some slightly better economic news in China, with February industrial production growing 7.5% year-over-year (Y/Y) and retail sales growing 6.7% Y/Y; however, investors seemed to ignore this, focusing more on the geopolitical situation. Elsewhere, the market was surprised that we saw no MLF rate cut by the People’s Bank of China, despite better February data.

In Hong Kong it was a similar story, with weaker markets Monday and Tuesday. Technology and property names were particularly hard hit once again.

After a couple bearish days, on Wednesday, we started to see a reversal, with “dip buying” seen across the region. Regulatory concerns attributed for recent volatility amid a threat the United States would delisting China stocks from the NYSE abated somewhat, with China keeping dialogue open with US regulators and announcing that it would keep supporting overseas share listings, as well as vowing to keep stock markets stable. Reuters’ Tankan Survey showed Japan manufacturer sentiment firmed, but services sector sentiment weakened amid reintroduction of COVID-19 restrictions and inflation pressures.

On Thursday we continued to see a proper bounce in markets. Deeply oversold conditions, liquidity, one-sided positioning, and cheap valuations all suspected of magnifying the rebound. In China, the sharp upswing was attributed to government commentary about supporting the economy and markets; also, a drop in new COVID-19 cases offered some reprieve after Shenzhen allowed some companies to resume operations, easing concerns of a prolonged lockdown. Indications of a softer approach on tackling real estate risks was attributed for a surge in property developers. On the economic front, some highlighted Chair Powell’s reassurance about growth as a positive for risk sentiment, and we heard dovish remarks from Bank of Japan (BOJ) Governor Kuroda, who reiterated that it was too early to talk about exiting stimulus given below-target inflation.

We saw a mixed day on Friday, with China’s equity rally halted. President Biden spoke with China’s President Xi Jinping amid heightened tensions over Russia’s invasion, with Biden seeking to convince China to increase pressure on Moscow after Secretary of State Blinken said Biden will make clear the United States will not hesitate to impose costs on Beijing if it supports Russia’s invasion. China continued to deny the accusations and on Thursday described itself as a “friendly country” for Ukraine. BOJ left policy settings unchanged as expected, an easing bias maintained with the BOJ vowing to continue stimulus until inflation rises above 2% in a stable manner.

Week Ahead

Macro Week Ahead Highlights

NATO members meet in Brussels to discuss further actions to stop the Russian aggression. Attention will be on US President Biden, who’ll join in person on 24 March. After the Fed lifted interest rates and signalled interest-rate hikes at all remaining meetings this year, Powell will be speaking in Washington on Monday. Finally, on Wednesday, UK Chancellor of the Exchequer Rishi Sunak delivers his “Spring Statement” to parliament, outlining the government’s public spending plans and priorities.

Calendar

Monday 21 March

• Germany Producer Price Index (PPI)

Tuesday 22 March

• UK public finances (Public Sector Net Cash Requirement)
• Eurozone ECB current account (CA)
• Italy CA balance
• Eurozone construction output
• ECB President Christine Lagarde is scheduled to speak at the BIS Innovation Summit
• US Richmond Fed manufacturing survey

Wednesday 23 March

• UK Consumer Price Index and Retail Price Index
• UK spring statement
• Eurozone consumer confidence
• BOE Governor Andrew Bailey and Fed Chair Jerome Powell are due to speak on a panel about “challenges for central bank governors in a digital world”

Thursday 24 March

• France manufacturing confidence
• Eurozone Markit and Eurozone Manufacturing Purchasing Managers’ Index (PMI)
• Australia PMIs
• Japan PMIs and PPI
• US President Joe Biden is scheduled to meet NATO and European leaders in Brussels.
• US Jobless claims, CA, and durable goods

Friday 25 March

• UK retail sales including automobile fuel
• Spain gross domestic product (GDP)
• US state employment

Franklin Templeton Key risks & Disclaimers:

What Are the Risks?

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 21 March 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.