Market insights

Weekly market commentary

US & Japan: a tale of two overweights

Market take

Weekly video_20240318

Nicholas Fawcett

Opening frame: What’s driving markets? Market take

Camera frame

Inflation is in the spotlight again, thanks to some recent data surprises and the U.S. Federal Reserve and Bank of Japan both holding meetings this week.

Title slide: US & Japan: a tale of two overweights
Markets see a positive near-term macro backdrop in the US and Japan. We eye risks for both ahead – but for different reasons.

1: US inflation
US inflation has eased over the past few years thanks to rapidly falling goods prices.

Inflation will likely fall further toward 2% this year, in our view. But persistent services inflation will likely pull it back up in 2025 as the drag from falling goods prices fades. We see US inflation settling closer to 3% than 2% over the medium term, as a result.

2: Market sentiment
Markets are, for now, comfortable that US inflation will cool enough to allow the Fed to make three quarter-point rate cuts this year.

We think upbeat market sentiment can persist as inflation cools and rate cuts come through.

3: BOJ policies
The Bank of Japan, meanwhile, is focused on keeping inflation sustainably at 2% after decades of low or no inflation.

We expect the BOJ to end its emergency policy of negative rates, but to remain cautious - and not start tightening policy too aggressively.

Outro: Here’s our Market take
We’re overweight US and Japan stocks.

Yet resurgent inflation in the US could spoil sentiment. So we stay nimble.

Japan’s outlook remains positive to us as we don’t think the BOJ will raise rates aggressively and given ongoing corporate reforms.

Closing frame: Read details:

www.blackrock.com/weekly-commentary

Different macro outlooks

Markets see a positive near-term macro and corporate backdrop for the US and Japan. We eye risks ahead but remain overweight stocks in both countries.

Market backdrop

US stocks were largely flat last week after hotter-than-expected inflation data. Both 10-year US 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 US and Japanese macro environments. US 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 US and Japan stocks.

Paragraph-2,Image-1,Paragraph-3
Paragraph-4,Advance Static Table-1,Paragraph-5,Advance Static Table-2,Paragraph-6,Advance Static Table-3

An inflation rollercoaster

US core CPI inflation breakdown three-month annualised, 2017-2024

The orange line in the chart shows that US goods inflation has fallen sharply, but rose in February. A yellow line shows services inflation fell through mid-2023 but has picked up, and accelerated in January.

Source: BlackRock Investment Institute, US Bureau of Labor Statistics, with data from Haver Analytics, March 2024. Notes: The chart shows core US CPI goods and services inflation measured by the change in the most recent three-month average, at an annualised rate. Core goods inflation covers all goods, excluding energy and food costs. Core services inflation covers all services, excluding energy and shelter costs.

We’ve said before that this new macro and market regime is marked by persistent, structural inflation pressures. We think US 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 US 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 normalise 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 normalising 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 US 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

US 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 US and Japan stocks.

Market backdrop

US stocks retreated from near all-time highs to end the week largely unchanged, surrendering gains after the US CPI and other inflation gauges surprised to the upside. US 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. US 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

The chart shows that Brent crude are the best performing asset year-to-date among a selected group of assets, while the 10-year US Treasury yield is the worst.

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 LSEG Datastream as of March 14, 2024. Notes: The two ends of the bars show the lowest and highest returns at any point 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 US dollars, and the rest in local currencies. Indexes or prices used are: spot Brent crude, ICE US Dollar Index (DXY), spot gold, MSCI Emerging Markets Index, MSCI Europe Index, LSEG Datastream 10-year benchmark government bond index (US, 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.

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

Read our past weekly commentaries here.

Big calls

Our highest conviction views on tactical (6-12 month) and strategic (long-term) horizons, March 2024

Note: Views are from a US dollar perspective, March 2024. This material represents an assessment of the market environment at a specific time and is not intended to be a forecast of future events or a guarantee of future results. This information should not be relied upon by the reader as research or investment advice regarding any particular funds, strategy or security.

Tactical granular views

Six to 12-month tactical views on selected assets vs. broad global asset classes by level of conviction, March 2024.

Legend Granular

Our approach is to first determine asset allocations based on our macro outlook – and what’s in the price. The table below reflects this. It leaves aside the opportunity for alpha, or the potential to generate above-benchmark returns. The new regime is not conducive to static exposures to broad asset classes, in our view, but it is creating more space for alpha. For example, the alpha opportunity in highly efficient DM equities markets historically has been low. That’s no longer the case, we think, thanks to greater volatility, macro uncertainty and dispersion of returns. The new regime puts a premium on insights and skill, in our view.

Past performance is not a reliable indicator of current or future results. It is not possible to invest directly in an index. Note: Views are from a US dollar perspective, March 2024. This material represents an assessment of the market environment at a specific time and is not intended to be a forecast or guarantee of future results. This information should not be relied upon as investment advice regarding any particular fund, strategy or security.

Euro-denominated tactical granular views

Six to 12-month tactical views on selected assets vs. broad global asset classes by level of conviction, March 2024.

Legend Granular

Asset Tactical view Commentary
Equities    
 Europe ex UK Europe ex-UK: tactical Underweight -1 We are underweight. We see the European Central Bank holding policy tight in a slowdown and the support to growth from lower energy prices is fading.
Germany Germany: tactical Underweight -1 We are underweight. Valuations are moderately supportive relative to peers, but we see earnings under pressure from higher interest rates, slower global growth and medium-term uncertainty on energy supply. Longer term, we think the low-carbon transition may bring opportunities.
France France: tactical Underweight -1 We are underweight. Relatively richer valuations and a potential drag to earnings from weaker consumption amid higher interest rates offset the positive impact from past productivity enhancing reforms and favorable energy mix.
Italy Italy: tactical Underweight -1 We are underweight. The economy’s relatively weak credit fundamentals amid global tightening financial conditions keep us cautious even though valuations and earnings revision trends look attractive versus peers.
Spain Spain: tactical Underweight -1 We are underweight. Valuations and earnings momentum are supportive relative to peers, but the uncertain outcome of Spanish elections is a temporary headwind.
Netherlands Netherlands: tactical Underweight -1 We are underweight. The Dutch stock markets' tilt to technology and semiconductors, a key beneficiary of higher demand for AI, is offset by relatively less favorable valuations and earnings momentum than European peers.
Switzerland Switzerland: tactical Overweight +1 We are overweight. We hold a relative preference. The index’s high weights to defensive sectors like health care and non-discretionary consumer goods provide a cushion amid heightened global macro uncertainty. Valuations remain high versus peers and a strong currency is a drag on export competitiveness.
UK German bunds: tactical Neutral We are neutral. We find that attractive valuations better reflect the weak growth outlook and the Bank of England’s sharp rate hikes to deal with sticky inflation.
Fixed income    
Euro area government bonds Euro area government bonds: tactical Neutral We are neutral. Market pricing reflects policy rates in line with our expectations and 10-year yields are off their highs. Widening peripheral bond spreads remain a risk.
German bunds German bunds: tactical Neutral We are neutral. Market pricing sets a high bar for dovish ECB surprises and 10-year yields are off their highs.
French OATs French OATs: tactical Neutral We are neutral. Valuations look moderately compelling compared to peripheral bonds, with French spreads to German bonds hovering above historical averages. Elevated French public debt and a slower pace of structural reforms remain headwinds.
Italian BTPs German bunds: tactical Neutral We are neutral. The spread over German Bunds looks tight amid sluggish global macro, the ECB holding policy tight and Italian fiscal policy back in the limelight / fiscal targets under pressure. Other domestic factors remain supportive, namely a more balanced current account. For now, we see income helping to compensate for the slightly wider spreads we expect.
UK gilts UK gilts: tactical Neutral We are neutral. Gilt yields have compressed relative to US Treasuries. Markets are pricing in Bank of England policy rates closer to our expectations.
Swiss government bonds Swiss government bonds: tactical Neutral We are neutral as the Swiss National Bank approaches peak policy rates amid relatively subdued inflation in international comparison and a strong currency. Further upward pressure on yields appears limited given global macro uncertainty.
European inflation-linked bonds Euro area inflation-lined bonds: tactical Underweight -1 We prefer the US over the euro area. We see markets overestimating how persistent inflation in the euro area will be relative to the US.
European investment grade credit European investment grade credit: tactical Neutral We are neutral European investment-grade credit. We maintain our preference for European investment grade over the US given more attractive valuations amid decent income.
European high yield European high yield: tactical Overweight +1 We are overweight. We find the income potential attractive. We still prefer European high yield given its more appealing valuations, higher quality and lower duration than in the US Spreads compensate for risks of a potential pick-up in defaults, in our view.

Past performance is not a reliable indicator of current or future results. It is not possible to invest directly in an index. Note: Views are from a euro perspective, March 2024. This material represents an assessment of the market environment at a specific time and is not intended to be a forecast or guarantee of future results. This information should not be relied upon as investment advice regarding any particular fund, strategy or security.

Meet the authors
Jean Boivin
Head – BlackRock Investment Institute
Wei Li
Global Chief Investment Strategist – BlackRock Investment Institute
Nicholas Fawcett
Macro Research – BlackRock Investment Institute
Tara Iyer
Chief US Macro Strategist – BlackRock Investment Institute

This material is for distribution to Professional Clients (as defined by the Financial Conduct Authority or MiFID Rules) and Qualified Investors only and should not be relied upon by any other persons.

Issued by BlackRock Investment Management (UK) Limited, authorised and regulated by the Financial Conduct Authority. Registered office: 12 Throgmorton Avenue, London, EC2N 2DL. Tel: 020 7743 3000. Registered in England No. 2020394. For your protection telephone calls are usually recorded. BlackRock is a trading name of BlackRock Investment Management (UK) Limited.

Past performance is not a reliable indicator of current or future results and should not be the sole factor of consideration when selecting a product or strategy.

Capital at risk. The value of investments and the income from them can fall as well as rise and is not guaranteed. You may not get back the amount originally invested. Changes in the rates of exchange between currencies may cause the value of investments to diminish or increase. Fluctuation may be particularly marked in the case of a higher volatility fund and the value of an investment may fall suddenly and substantially. Levels and basis of taxation may change from time to time.

Any research in this document has been procured and may have been acted on by BlackRock for its own purpose. The results of such research are being made available only incidentally. The views expressed do not constitute investment or any other advice and are subject to change. They do not necessarily reflect the views of any company in the BlackRock Group or any part thereof and no assurances are made as to their accuracy.

This document is for information purposes only and does not constitute an offer or invitation to anyone to invest in any BlackRock funds and has not been prepared in connection with any such offer.

© 2024 BlackRock, Inc. All Rights reserved. BLACKROCK, BLACKROCK SOLUTIONS, iSHARES, BUILD ON BLACKROCK and SO WHAT DO I DO WITH MY MONEY logo are registered and unregistered trademarks of BlackRock, Inc. or its subsidiaries in the United States and elsewhere. All other trademarks are those of their respective owners.