Woman standing on a train platform while train is speeding by
2022 MIDYEAR GLOBAL OUTLOOK

Back to a volatile future

We are braving a new world of heightened macro volatility – and investors are demanding more compensation for the risk of holding both bonds and equities. We stay pro-equities on a strategic horizon but are underweight in the short run.

Investment themes

01

Bracing for volatility

We have entered a regime of higher macro and market volatility. This implies that market views may have to change more quickly and get more granular.

02

Living with inflation

We see the Fed ultimately living with higher inflation as it sees the effect of its rate hikes on growth and jobs. For now, the Fed seems to be responding solely to the politics of inflation. This has caused us to reduce portfolio risk.

03

Positioning for net zero

Investing in high-carbon-emitting companies with credible transition plans or that are key to the transition can give investors exposure to the transition as well as mitigate the impact of its bumps.

Read details of our midyear outlook:

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

The Great Moderation is over

The Great Moderation, from mid-1980s until 2019 before the Covid-19 pandemic struck, was a remarkable period of stability of both growth and inflation. We were in a demand-driven economy with steadily growing supply. Borrowing binges drove overheating, while collapsing spending drove recessions. Central banks could mitigate both by either raising or cutting rates.

That period has ended, in our view. 

A regime shift

This chart shows that growth and inflation volatility has spiked since the onset of the pandemic, ending decades of stable growth and low inflation.

Sources: BlackRock Investment Institute, U.S. Bureau of Economic Analysis and Labor Department, with data from Haver Analytics, March 2022. Notes: The chart shows the standard deviation of the annualized quarterly change of U.S. real GDP and the core Consumer Price Index.

A regime shift

The pandemic upended an unusual period of mild volatility in output and inflation. 

Production constraints

First, production constraints – stemming from a massive shift in spending and labor shortages – are hampering the economy and driving inflation.

Record debt levels

Second, record debt levels mean small changes in interest rates have an outsized impact on governments, households and companies.

Everything is political

Third, we find the hyper-politicization of everything amplifies simplistic arguments, making for poorer policy solutions.

Bracing for volatility

This new market environment has echoes of the early 1980s. We are bracing for volatility in this regime. Central banks are rushing to raise rates to contain inflation that’s rooted in production constraints. They are not acknowledging the stark trade-off: crush economic growth or live with inflation.

The Fed, for one, is likely to choke off the restart of economic activity - and only change course when the damage emerges. We see this driving high macro and market volatility, with short economic cycles. Equities would suffer if rate hikes trigger a growth downturn. If policymakers tolerate more inflation, bond prices would fall. Either way, the macro backdrop is no longer conducive for a sustained bull market in both stocks and bonds, we believe. We see higher risk premia across the board and think portfolio allocations will need to become more granular and nimble.

Living with inflation

We think we will be living with inflation. For all the noise about containing inflation, we see policymakers ultimately living with some of it. We remain overweight equities and underweight government bonds in long-term portfolios. We expect investors to demand more compensation to hold long-term bonds in this new regime. We see a high risk of growth stalling and reduce equities to underweight. We now prefer to take risk in credit because we don’t see contained default risk.

Positioning for net zero

We see the bumpy transition to net-zero carbon emissions shaping the new regime – and believe investors should start positioning for net zero. We think investors can be bullish on both fossil fuels and sustainable assets, as we see a key role for commodities in the transition. Yet our work finds that changing societal preferences can give sustainable assets a return advantage for years to come.

Ready to shift views

We stay pro-equities on a strategic horizon but are underweight in the short run.

Biases built up during the Great Moderation, like buying risk asset dips, won’t work as well as before, in our view. A new regime of greater macro volatility, shorter cycles and more volatile markets, means a dynamic approach to portfolio positioning. Our conviction is that portfolios will need to change more quickly.

Ready to shift views

Our conviction is that portfolios will need to change more quickly. For example, on equities and credit, central banks slamming on the policy brakes as inflation remains persistently above target could make us more negative. Download the full report above to learn more about the signposts for changing our investment views.

Directional views

Strategic (long-term) and tactical (6-12 month) views on broad asset classes, July 2022

legend granular

Note: Views are from a U.S. dollar perspective. 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, July 2022

Legend Granular

Note: Views are from a U.S. dollar perspective, July 2022. 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.

Massive sectoral reallocation

The U.S. has seen its largest sectoral shift on record as spending moved from services to goods – and it hasn’t normalized yet. Major spending shifts and production constraints are the driving force of inflation rather than excessive demand.

Absolute change in U.S. spending shares and averages, 1960-2022

This chart shows a massive an unprecendted of expenditure share during Covid relative to the normal shift in those shares historically.

BlackRock Investment Institute and U.S. Bureau of Economic Analysis, with data from Haver Analytics, March 2022. Notes: The chart shows the absolute quarterly change in the share of nominal consumer spending across 121 components of U.S. personal consumption expenditure. The spike shows the un usual shift to goods from services during the pandemic. The gray band shows the range of quarterly changes indicating a return to the pre-Covid spending mix over the next 6 to 18 months.

Rate sensitivity

The sensitivity of high debt levels to higher interest rates makes it harder to contain inflation via rates. Central banks are likely to veer between favoring activity over inflation, and vice versa. We may see higher inflation and short cycles.

U.S. net debt interest payments and scenarios, 1990-2025

This chart shows that higher projected policy rates may result in higher net interest rate payments, which is problematic for debt repayments.

Forward-looking estimates may not come to pass. Past performance is not a reliable indicator of current or future results. Sources: BlackRock Investment Institute, OECD and International Monetary Fund, with data from Haver Analytics, December 2021. Notes: The chart shows historical U.S. net interest payments and projections for U.S. net interest payments based on different interest rate scenarios on a five-year horizon. The scenarios are calculated based on IMF projections of U.S. debt and hypothetical calculations of debt interest costs based on different assumptions for the path of interest rates as indicated in the legend.

The return of yield

Investors benefit from owning credit nowadays. Most fixed income assets are yielding 4% or more for the first time in over a decade. The pandemic policy response allowed firms to boost cash buffers and issue longer-term debt at record-low interest rates.

Share of fixed income indices yielding 4% or more, 1999-2022

This chart shows that after more than a decade, most fixed income assets are now yielding 4% or more.

Past performance is not a reliable indicator of current or future results. Indexes are unmanaged and not subject to fees. It is not possible to invest directly in an index. Source: BlackRock Investment Institute, with data from Refinitiv Datastream, June 2022. Notes: The bars show market capitalization weights of assets with an average annual yield over 4% in a select universe that represents about 70% of the Bloomberg Mulitiverse Bond Index. Euro core is based on French and German government bonds indexes. Euro periphery is based on an average of government debt indexes for Italy, Spain and Ireland. Emerging markets combine external and local currency debt.

Higher risk premia

This stylized chart shows that since the Covid-19 shock, the underlying volatility of demand and supply shocks has risen.

Sources: Blackrock Investment Institute, July 2022. Notes: The chart shows a stylized depiction of the volatility of U.S. inflation and output during the Great Moderation (1985-2019; green line) and since the Covid-19 shock (2020 to now; orange line). The curves show potential combinations of output (x axis) and inflation (y axis) volatility that can be achieved when central banks react to demand and supply shocks hitting the economy. Since the Covid-19 shock, the underlying volatility of demand and supply shocks has risen, as the orange line shows. This means central banks now face starker trade-offs. They can try to rein in inflation, but this comes at a cost of higher output volatility- the Fighting inflation outcome bottom right. Or they can try to dampen fluctuations in output at a cost of more inflation volatility – the Living with inflation outcome upper left. For illustrative purposes only.

The Great Moderation fostered steady growth that led to decades-long bull runs for both stocks and bonds. Central banks could soften demand shocks and boost growth with looser policy – facing only a modest trade-off of inflation (the green line in the chart).

The end of this means much starker trade-offs, as the orange line shows. The entire curve shifted and grew, magnifying the impact of policy choices. At one end central banks crush growth to rein in inflation, raising recession risk and damaging equities.

At the other end, central banks go easy and face the risk of inflation soaring. Bond prices fall as investors demand a higher term premium. We expect this to be the main conundrum for 2023.

Bottom line: The Great Moderation is over. 
 

Meet the authors
Philipp Hildebrand
Vice Chairman, BlackRock
Jean Boivin
Head of BlackRock Investment Institute
Wei Li
Global Chief Investment Strategist, BlackRock Investment Institute
Alex Brazier
Deputy Head of BlackRock Investment Institute
Vivek Paul
Head of Portfolio Research, BlackRock Investment Institute
Scott Thiel
Chief Fixed Income Strategist

Receive BlackRock Insights straight to your inbox

Please try again
Email address *
Please enter a valid email
Investor type *
This field is mandatory
Country *
This field is mandatory
Company
This field is mandatory
Thank you
Thank you for your subscription!
We usually publish weekly insights on every Monday. Expect to receive your first newsletter from us this upcoming Monday.