Jean Boivin – Head of BlackRock Investment Institute together with Wei Li – Global Chief Investment Strategist, Nicholas Fawcett – Senior Economist and Michel Dilmanian – Portfolio 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
Coming around: Long-term bond yields have jumped as markets have embraced our previously contrarian high-for-longer view. But it doesn’t necessarily spell pain for stocks.
Market backdrop: U.S. stocks rose 3% last week, helped by tech gains, as Q4 corporate earnings kicked off. Soft U.S. and UK CPI sent bond yields tumbling from recent highs.
Week ahead: We expect the Bank of Japan to hike rates this week as it carefully normalizes policy. We watch for currency moves and any global ripple effects that follow.
Surging bond yields around the globe represent a big shift toward our view: we are in a world of higher interest rates and expect them to stay above pre-pandemic levels. Even with the jump in yields, we still see more room to run, if at a slower pace – a reason we stay underweight U.S. 10-year Treasuries for now. We favor short-dated Treasuries and credit for income. We prefer taking risk in stocks and expect corporate earnings to keep driving returns as Q4 reporting season starts.
We have long argued that structural forces, such as aging labor forces at a time of ever-rising debt, would keep inflation and interest rates higher for longer. This view is now consensus. Surging global yields show shifting market narratives, from deep rate cuts to almost no cuts, keep driving sharp volatility. These moves go beyond market expectations of higher inflation: real yields on inflation-linked bonds have been the main driver of the recent surge. We think some of the volatility is driven by expecting the Federal Reserve to respond in a typical way to a business cycle. This is the wrong lens at a time of structural transformation and when the government debt backdrop is very different. Investors are demanding more compensation for the risk of holding long-term bonds, driving the term premium to a decade high. See the chart. That shows the market coming around to our higher-for-longer view.
Yet this is not a business cycle. We are in an economic transformation – with structural shifts driving activity. We have never before seen today’s combination of sticky inflation, higher policy rates and high and rising debt levels. This combination represents a fragile equilibrium supporting investor demand for long-term bonds. Yet investor sentiment and risk appetite can shift quickly in this environment – threatening to throw this equilibrium off-kilter. We have seen that in the UK recently, where fiscal concerns helped drive 10-year gilt yields to 17-year highs. We stay overweight gilts for income – yet monitor the UK’s outlook as it faces the sharpest trade-off between growth and inflation among developed markets, in our view.
Our fixed income and credit views
In the U.S., large and persistent deficits were expected even before the new administration makes any changes to fiscal policy – like the proposed extension of tax cuts. As bond markets absorb record Treasury issuance, we think long-term yields can rise further – though they have come a long way in a short period of time. That keeps us underweight U.S. 10-year Treasuries as we think yields could pass 5%. We prefer earning income in short-dated Treasuries and credit. Even with the recent jump in bond yields, credit spreads have stayed tight. Investment grade corporates have stronger balance sheets after the pandemic, even as they start to refinance at higher interest rates – a reason we prefer short-dated investment grade credit over government bonds. Within investment grade, solid corporate earnings momentum supports tighter spreads, in our view.
Even in a higher-rate environment, we still think stocks can keep pushing higher as long as fundamentals stay strong. The magnificent seven companies driving corporate earnings growth have strong balance sheets, are cash rich and have negative net debt. This makes them more resilient to the bite of higher rates. Early signs are positive that earnings momentum can persist: consensus forecasts call for overall U.S. earnings to grow 13% in 2025, up from 10% last year, LSEG Datastream data show. We watch Q4 earnings season for signs of this strength persisting and broadening to sectors beyond tech. We stay risk-on for now as we expect AI beneficiaries to broaden out yet eye triggers that could cause us to change our view.
Our bottom line
We think bond yields can keep climbing over the long term, so we stay underweight long-dated U.S. Treasuries. We prefer short-term bonds for income and euro area over U.S. credit. We stay risk-on and expect earnings to fuel equities.
Market backdrop
U.S. stocks rose 3% last week, helped by tech gains, as Q4 earnings season kicked off. Strong Q4 results and solid forward guidance from several big banks supported risk sentiment. Global bond yields walked back some of their recent rise following surprisingly soft core inflation data in both the U.S. and UK. U.S. 10-year Treasury yields fell from 14-month highs to around 4.62%, while UK 10-year gilt yields finished the week near 4.66% after reaching 17-year highs earlier this month.
We are watching Japan this week. The country is benefiting from the long-awaited return of mild inflation and its fastest pace of wage growth in three decades. Ongoing corporate reform efforts and shareholder-friendly policies, such as stock buybacks, are driving improved corporate earnings and business sentiment. The consensus expects the BOJ to hike policy rates this week. We expect the BOJ to proceed carefully with its policy normalization after last year’s spook to markets.
Week Ahead
Jan. 21: UK unemployment
Jan. 23: Bank of Japan (BOJ) policy decision; Japan trade data
Jan. 24: Global flash PMIs; Japan CPI
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