Day: 4 July 2023

Jean Bovin – Head of BlackRock Investment Institute, together with Wei Li – Global Chief Investment Strategist, Alex Brazier – Deputy Head, and Vivek Paul – Head of Portfolio 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.

Key Points

Evolving our playbook: We see different and abundant opportunities in the new macro regime. We go granular within asset classes, regions and sectors – and harness mega forces.

Market backdrop: Short-term bond yields rose last week as markets priced policy rates staying tight after U.S. data confirmed persistent inflation and activity holding up.

Week ahead: U.S. jobs data is in focus this week. We think labor shortages have made firms reluctant to let workers go, keeping unemployment low even as growth sputters.

We see major central banks holding policy tight in the new macro regime. That bolsters income’s appeal. We’re also pivoting to new opportunities, evolving our playbook to go granular across asset classes, regions and sectors: The outlook is brightening for Japanese stocks, and we like emerging market (EM) debt as policy looks poised to loosen. We harness mega forces as well, leaning into the digital disruption of AI and private credit as it plays a bigger role in the future of finance.

Markets have come around to the view that major central banks will not quickly ease policy in a world shaped by supply constraints – notably worker shortages in the U.S. Developed markets (DM) can no longer produce as much without sparking higher inflation. So, central banks are holding tight, the first new investment theme in our 2023 midyear outlook. That’s a big change from the low-rate environment norm prior to the pandemic. Take the Federal Reserve. It has kept monetary policy loose since the early 1990s – and was quick to cut rates when recessions hit. See the yellow line and gray shaded areas in the chart. We don’t see the Fed coming to the rescue. We see more supply constraints in the future compelling central banks to keep policy rates above neutral rates (red line), the estimated policy rate that neither stimulates nor depresses economic growth. That means policy is going to stay in restrictive territory.

Policy rates staying tight bolsters the appeal of income – and the case for short-dated government paper. Three-month U.S. Treasury bill yields hit 22-year highs near 5.60% in June. We stay underweight long-term U.S. government bonds as we expect investors to demand more compensation for holding them given sticky inflation. Yet long-term bonds in the euro area and the UK are better pricing higher rates, so we’re tactically neutral. We stay strategically overweight inflation-linked bonds on persistent inflation. But tactically, we prefer the U.S. over the euro area given current market pricing of each.

The new layers of our playbook

The macro backdrop is not friendly for broad asset class returns, but opportunities abound depending on how much of the macro is in asset prices. So we’re pivoting to new opportunities, our second theme, and getting granular. We’re modestly underweight DM equities in our six- to 12-month tactical view as they still don’t price the damage from rate hikes. But Japan stands out. We upgrade Japan stocks to neutral. Why? Fewer supply constraints, supportive policy and corporate reforms. We tactically prefer EM equities to DM peers as EM policy looks closer to easing. But on a strategic horizon of five years and beyond, we’re overweight DM stocks as we see returns above bonds’ with growth returning and inflation lingering in the U.S.

Our third theme, harnessing mega forces, aims to leverage structural shifts that transcend the macro: digital disruption and AI, geopolitical fragmentation, the low-carbon transition, aging populations and the future of finance. The key is gauging what markets have priced in. We see these mega forces driving returns today and in the future. Case in point: The dip in semiconductor shares last week on potential U.S. export restrictions to China after this year’s surge shows how mega forces like AI and geopolitical fragmentation can interact and impact markets now. We’re overweight AI as a multi-country, multi-sector investment cycle unfolds, bolstering revenues and margins. We see geopolitical fragmentation rewiring supply chains and putting national security and resilience above efficiency. The upshot: We expect a surge in investment in areas like tech, clean energy, infrastructure and defense. We see other opportunities in the low-carbon transition’s large capital reallocation – and across the energy system to get in front of shifts before markets. We also see regulatory and competition challenges for incumbent banks in the fast-evolving financial system, but also opportunities for non-bank lenders. We think private credit could help fill a void left by banks pulling back on lending after the tumult this year.

Bottom line

We’re pivoting to new opportunities by getting granular as a tight policy environment makes it tough for broad asset class returns. We also harness mega forces to tap into structural shifts and upside beyond the macro backdrop.

Market backdrop

Short-term DM bond yields climbed last week as the market priced policy rates staying tight. The two-year U.S. Treasury yield pushed above 4.90%, pulling the U.S. yield curve near its most inverted level since the early 1980s. U.S. stocks hit 14-month highs after Q1 U.S. data on output and income was revised up. We think activity is holding up thanks to households spending pandemic savings – and persistent inflation as seen in PCE data may mean policy rates need to go even higher.

The focus in next week’s U.S. job report will be prevailing signs of a resilient labor market even with tight monetary policy. We see labor shortages fueling wage growth and keeping inflation stubbornly high as companies hold on to workers even as demand drops. That poses the unusual risk of “full employment recessions,” where the unemployment rate stays low. 

Week Ahead

July 3: U.S. ISM manufacturing PMI

July 4: Reserve Bank of Australia policy decision

July 5: China Caixin services PMI; S&P global services PMIs; 

July 7: U.S. jobs report

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