Jean Boivin Head of BlackRock Investment Institute together with Wei Li – Global Chief Investment Strategist, Nicholas Fawcett – Macro Research and Tara Iyer – Chief U.S. Macro Strategist 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
Different macro outlooks: Markets see a positive near-term macro and corporate backdrop for the U.S. and Japan. We eye risks ahead but remain overweight stocks in both countries.
Market backdrop: U.S. stocks were largely flat last week after hotter-than-expected inflation data. Both 10-year U.S. Treasury and Japanese government bond yields rose.
Week ahead: The Fed policy decision is in focus this week. We see Fed rates staying higher for longer than pre-pandemic. We watch how the Bank of Japan interprets inflation.
Federal Reserve and Bank of Japan (BOJ) meetings this week and recent data put a spotlight on the U.S. and Japanese macro environments. U.S. markets are pricing in a positive macro backdrop as inflation cools. We don’t see upbeat risk appetite being seriously challenged in coming months. By contrast, Japan’s macro and corporate outlook is positive longer term. We see the BOJ simply ending negative interest rates, not starting to tighten. We stay overweight U.S. and Japan stocks.
We’ve said before that this new macro and market regime is marked by persistent, structural inflation pressures. We think U.S. inflation can fall further toward 2% this year due to falling goods prices. See the orange line in the chart. Yet we see it on a rollercoaster back up in 2025 as the drag from goods deflation fades and elevated wage growth in a tight labor market keeps services inflation higher than pre-pandemic. Inflation is likely to settle above the Fed’s 2% target in 2025. The spike in services inflation for January (yellow line) now looks like a one-off, but we think it keeps inflation on an elevated track that is inconsistent with overall inflation at 2%. And after months of falling good prices driving inflation lower, they suddenly rose in February. We see more goods deflation to come in the near term. Yet these one-offs may be offering a glimpse of the trickier inflation environment ahead later this year.
Markets are, for now, comfortable that inflation will cool enough to allow the Fed to make three quarter-point rate cuts this year and keep cutting. We think upbeat sentiment can persist as inflation keeps falling. That’s why we stay overweight U.S. stocks and lean into the artificial intelligence theme as tech drives corporate earnings growth. The earnings recovery in other sectors is supporting risk appetite. Yet inflation could come in stronger than markets expect again and challenge risk-taking. That outcome would limit how far and how fast the Fed can cut rates from restrictive levels. We see Fed policy rates staying higher than before the pandemic as inflation likely settles closer to 3%. We believe that calls for staying nimble in portfolios.
The macro outlook for Japan
Meanwhile, the BOJ is focused on keeping inflation sustainably at 2% after decades of ultra-low inflation. Its challenge: gauging how to normalize monetary policy without undermining its hard-won revival of expectations for sustained inflation, in our view. Rising import prices have helped Japan’s inflation rise above 2%. Yet keeping inflation there will require such expectations to feed through domestic prices and wages. The good news: Annual union wage negotiations resulted in pay gains topping 5%, the largest since the early 1990s. That should boost the BOJ’s conviction of overcoming a decades-long undershoot of its inflation target. Markets are pricing that the BOJ could end negative interest rates as soon as this week. If markets see the policy shift as normalizing policy, we think that would support risk appetite. Yet if this policy change is viewed as the BOJ getting nervous about inflation, that could spell bad news for sentiment.
Without buffering for swings in the yen, we’re overweight Japanese stocks. Their outlook seems positive given mild inflation, strong earnings growth and ongoing corporate reforms. Our overweight there will likely remain for longer than our U.S. stock overweight over a six- to 12-month tactical horizon. We’ve been underweight Japanese government bonds since July 2022. We expect yields to rise as the BOJ winds down loose policy, including yield curve control, even if likely in a measured manner.
Our bottom line
U.S. inflation has been volatile recently, but we expect it to fall further this year before resurging in 2025. We see the BOJ ending negative interest rates – but eye risks to market sentiment. We’re overweight U.S. and Japan stocks.
Market backdrop
U.S. stocks retreated from near all-time highs to end the week largely unchanged, surrendering gains after the U.S. CPI and other inflation gauges surprised to the upside. U.S. 10-year yields jumped more than 20 basis points to near 4.30% after February CPI was hotter than expected, prompting markets to price out Fed rate cuts. Japanese 10-year yields reached this year’s high near 0.8% as markets eye an end to negative rates this week. U.S. crude oil prices gained 4% on supply concerns.
The Fed policy decision is the main event this week. Although markets don’t expect the first rate cut until midyear, we think they’ll focus on how the Fed is responding to recent higher-than-expected inflation data. Markets may also assess whether Fed projections indicate a more persistent inflation outlook. Meanwhile, the BOJ could end its negative interest rate policy as soon as this week, with markets pricing a small hike. We also await the Bank of England policy decision.
Week Ahead
March 19: BOJ policy decision
March 20: Fed policy decision; UK CPI; euro area consumer confidence
March 21: BOE policy decision; global flash PMIs; Japan trade data
March 22: Japan CPI
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