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Q2 2022 GLOBAL OUTLOOK
Navigating the new market regime
Much has changed since our 2022 outlook - a war, energy shock and the Federal Reserve’s pivot on monetary policy. We stay underweight bonds, even as yields have sprinted upward, and overweight equities – with new regional differences.
Investment themes
01
Living with inflation
We expect central banks to quickly normalize policy, with rates rising from historically low levels. We see a higher risk of the Fed slamming the brakes on the economy as it has struck a hawkish tone. Implication: We prefer equities over fixed income and overweight inflation-linked bonds.
02
Cutting through confusion
The Ukraine war has aggravated inflation pressures and has put central banks in a bind. Trying to contain inflation will be costly to growth and employment, and they can’t cushion the growth shock. Implication: We have tweaked our risk exposure to favor equities at the expense of credit.
03
Navigating net zero
Europe’s drive to wean itself off Russian gas should reinforce the net-zero transition. Yet some regions will produce more fossil fuels in the near-term as global energy systems are rewired. Implication: We favor developed market equities over emerging markets.
Learn more about our 2022 Outlook:
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A new market regime
We see 2022 heralding a new regime by delivering global stock gains and bond losses for a second year – what would be a first since data started in 1977. This unusual outcome is the next phase of our new nominal theme that is still playing out: Central banks and bond yields have been slower to respond to higher inflation in the powerful restart than in the past. That should keep real, or inflation-adjusted, bond yields historically low and support stocks.
The big change in 2022: Central banks will be withdrawing some monetary support as the restart does not need stimulus. We see more moderate equities returns as a result. We expect the Fed to kick off rate hikes but remain more tolerant of inflation. The Fed has achieved its inflation target, so its interpretation of its employment mandate will determine the timing and pace of higher rates. The European Central Bank, facing a weaker inflation outlook, is likely to stay easier on policy.
We had flagged inflation - now we’re Living with inflation.
A restart like none other
We’ve never had an economic restart like this. Add repeated, outsized data surprises to the mix – both to the upside and the downside – and confusion is natural among policymakers and markets adapting to a new reality.
At the same time, central banks are implementing new frameworks that change how they react to inflation. The risks arising from new Covid-19 strains only add to the confusion. We cut through numerous possibilities to ask: What would it take for us not to be in this new market regime?
What could go wrong?
We see two ways our new market regime view could be wrong. First, central banks might react differently. They could – in the face of persistent inflation pressures, perhaps tied to new Covid-19 strains, revert to their old response to inflation.
Central banks could also be forced to be more aggressive if inflation expectations become de-anchored. We would be faced with inflation significantly above target, rising interest rates and falling growth: a classic stagflation scenario that is bad for both bonds and equities. Second, we could be wrong about growth prospects.
The chart shows how different our and the market’s view of future Fed rate hikes is from how the Fed might have reacted historically to the current mix of slack and inflation. In the past, we believe the Fed would have been pushing up rates in 2021 - again helping confirm this is a new regime.
It’s different this time
U.S. CPI inflation, federal funds rate and estimates, 1990-2025
Forward-looking estimates may not come to pass. Source: BlackRock Investment Institute, Federal Reserve Board, U.S. Bureau of Labor Statistics, Bloomberg, with data from Haver Analytics, December 2021. Notes: The chart shows the U.S. nominal federal funds rate (orange line), year on year headline CPI inflation (yellow) and some projected paths of the nominal federal funds rate. The U.S. CPI shown from 2022 - 2025 are our estimate embedded in our Capital Market Assumptions. The dotted red line shows our own projection of the federal funds rate. The purple line shows the path that would have been implied by a simple monetary policy rule linking the choice of policy rate to the rate of inflation and the level of the output gap. The pink line shows the current market-implied path.
Staying invested
How to thrive in this new market regime? We prefer equities in the inflationary backdrop of the strong restart. We favor DM stocks over as we dial down risk slightly amid rising risks to our base case.
We are underweight DM government bonds – we see yields gradually heading higher but staying historically low. We prefer inflation- linked bonds, partly as portfolio diversifiers. On a strategic horizon, we like private markets for their diversification and return potential.
Staying invested
The backdrop for risk assets is favorable on a tactical horizon, yet less so than it was a year ago, in our view. We are trimming our tactical risk stance to one that is still pro- equities yet more balanced. This still means a modest equities overweight – with a preference for developed markets over emerging – amid strong growth and low real yields.
Directional views
Strategic (long-term) and tactical (6-12 month) views on broad asset classes, December 2021
| Asset | Strategic view | Tactical view | Commentary |
|---|---|---|---|
| Equities |  |
 |
We increased our strategic equities overweight in the early 2022 selloff. We saw an opportunity for long-term investors in equities because of the combination of low real rates, strong growth and a change in valuations. Incorporating climate change in our expected returns brightens the appeal of developed market equities given the large weights of sectors such as tech and healthcare in benchmark indices. Tactically, we favor developed market equities over emerging market stocks, with a preference for the U.S. and Japan over Europe. |
| Credit |  |
|
We are underweight credit on a strategic and tactical basis against a backdrop of rising interest rates and high valuations. We prefer to take risk in equities instead. Tactically, we overweight local-currency EM debt on attractive valuations and potential income. A large risk premium compensates investors for inflation risk, in our view. |
| Government bonds | |
|
We are strategically underweight nominal government bonds given their diminished ability to act as portfolio diversifiers with yields near lower bounds. We see investors demanding higher compensation for holding government bonds amid rising inflation and debt levels. We prefer inflation-linked bonds instead. Tactically, we also underweight government bonds as we see the direction of travel for long-term yields as higher – even as yields have surged in 2022. We prefer inflation-linked bonds as portfolio diversifiers in the higher inflation regime. |
| Private markets |  |
- | We believe non-traditional return streams, including private credit, have the potential to add value and diversification. Our neutral view is based on a starting allocation that is much larger than what most qualified investors hold. Many institutional investors remain underinvested in private markets as they overestimate liquidity risks, in our view. Private markets are a complex asset class and not suitable for all investors. |
Note: Views are from a U.S. dollar perspective, April 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.
Our granular views indicate how we think individual assets will perform against broad asset classes. We indicate different levels of conviction.
Tactical granular views
Six to 12-month tactical views on selected assets vs. broad global asset classes by level of conviction, December 2021
| Asset | Tactical view | Commentary | ||
|---|---|---|---|---|
| Equities | ||||
| Developed markets | |
We overweight DM stocks amid supportive fundamentals, robust earnings and low real yields. We see many DM companies well positioned in the inflationary backdrop thanks to pricing power. We prefer the U.S. and Japan over Europe. | ||
| United States | |
We overweight U.S. equities due to still strong earnings momentum. We see the Fed not fully delivering on its hawkish rate projections. We like the market’s quality factor for its resiliency to a broad range of economic scenarios. | ||
| Europe |  |
We are moderately overweight European equities as we expect the energy shock to hit European growth hard. We like the market’s cyclical bend in the inflationary backdrop and expect the ECB to only slowly normalize policy. | ||
| U.K. | |
We are neutral UK equities. We see the market as fairly valued and prefer other DM equities such as U.S. and Japanese stocks. | ||
| Japan |  |
We are overweight Japan equities on supportive monetary and fiscal policies - and the prospect of higher dividends and share buybacks. | ||
| China | |
We now see Chinese stocks as more risky, but improved valuations leave us moderately overweight. China’s ties to Russia have created a new geopolitical concern that requires more compensation for holding Chinese assets, we think. | ||
| Emerging markets | |
We are neutral EM equities and prefer DM equities, given more challenged restart dynamics, higher inflation pressures and tighter policies in EM. | ||
| Asia ex-Japan | |
We are neutral Asia ex-Japan equities. We prefer more targeted exposure to China because of easing monetary and regulatory policy. | ||
| Fixed income | ||||
| U.S. Treasuries | |
We underweight U.S. Treasuries even as yields have surged this year. We see long-term yields move up further as investors demand a higher premium for holding governments bonds. We prefer short-maturity bonds instead. | ||
| Treasury Inflation-Protected Securities | |
We overweight U.S. TIPS as we see inflation as persistent and settling above pre-Covid levels. We prefer TIPS as diversifiers in the inflationary backdrop. | ||
| European government bonds | |
We underweight European government bonds. We see yields heading higher even as markets have adjusted to price in an end to negative rates and beyond. | ||
| UK Gilts | |
We are neutral UK Gilts. We see market expectations of rate hikes as overdone amid constrained supply and weakening growth. | ||
| China government bonds | |
We overweight Chinese government bonds. Easier monetary policy alongside the relative stability of interest rates and potential income brighten their appeal. | ||
| Global investment grade | |
We underweight investment grade credit amid tight spreads and interest rate risk. We see more value in equities instead. | ||
| Global high yield | |
We are neutral high yield. We do not expect credit spreads to tighten but find the income potential attractive. We prefer to take risk in equities. | ||
| Emerging market - hard currency | |
We are neutral hard-currency EM debt. We expect it to gain support from higher commodities prices but remain vulnerable to rising U.S. yields. | ||
| Emerging market - local currency | |
We are modestly overweight local-currency EM debt on attractive valuations and potential income. Higher yields already reflect EM monetary policy tightening, in our view, and offer compensation for interest rate risk. | ||
| Asia fixed income | |
We stay overweight Asia fixed income. We find valuations in China compelling relative to risks. Outside China, we like Asian sovereigns and credit for income. | ||
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 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 or guarantee of future results. This information should not be relied upon as investment advice regarding any particular fund, strategy or security.
Our base case: New nominal
We expect mildly higher inflation with a muted central bank response, keeping real rates historically low. Stocks can thrive, but bonds still suffer as the yield curve modestly steepens.
Higher energy burdens
We see the energy shock hitting growth in Europe the hardest because of the region’s heavy reliance on Russian gas. Europe’s energy burden is more than twice that of the U.S.
Sources: BlackRock Investment Institute and BP Statistical Review of World Energy 2021, with data from Haver Analytics, March 2022. Notes: chart shows the cost of oil, gas and coal consumption in the European Union and U.S. as a share of GDP. We use regional energy prices and divide by GDP in U.S. dollars. Data for 2022 are based on IMF’s latest GDP forecasts and the year- to-date average of daily commodities prices.
Hawkish central bank policies
The Fed struck a surprisingly hawkish tone in kicking off its hiking cycle. We see a higher risk of the Fed slamming the brakes on the economy as it may have talked itself into a corner.
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. Sources: BlackRock Investment Institute, with data from Haver Analytics and Refinitiv Datastream, March 2022. Notes: The chart shows historical fed funds rate, current and year-ago market pricing in forward overnight index swaps and the Fed’s March 2022 projection based on the median dot of policymaker projections for the end of each year. The final green dot represents the Fed’s long-term policy rate expectation.
Other regimes explained
Safety premium questioned
The perceived safety of government bonds is questioned amid rising debt levels. Investors demand a larger compensation for the risk of holding long-term bonds. The yield curve steepens sharply. Yet this is a relative asset shift: equities can still do well.
Productivity boom
Sustained capital investment boosts potential growth, keeping the macro environment disinflationary. The Fed is patient and keeps policy loose, with rates below neutral. The yield curve steepens, real yields stay low, and risk assets do well.
Slamming the brakes
Delays to the restart, perhaps due to a new vaccine-resistant virus strain, result in weaker growth but persistently higher inflation. Central banks aggressively push against inflation, initially sparking a surge in yields. Result: recession with high inflation. The yield move hits stocks hard.
Runaway inflation
Inflation expectations become unanchored in the post-Covid confusion. A messy transition to net zero could exacerbate this. 1970s-style stagflation is back. Yields surge across the curve and risk assets sell off.
Stagnation
Growth slumps. Inflation pressures abate because labor market slack holds back wage growth. Central banks are unsuccessful in reviving growth and inflation. The yield curve flattens, and equities take a hit as earnings slump.
Classic risk-off
Asset bubbles form and burst. Trade wars flare up again and hurt global activity. Central banks struggle to respond. Long- term yields fall sharply from a flight to perceived safety and the term premium turns negative again. Risk assets suffer.
Meet the authors
Philipp Hildebrand
Vice Chairman of BlackRock
Jean Boivin
Head of BlackRock Investment Institute
Wei Li
Global Chief Investment Strategist – BlackRock Investment Institute
Alex Brazier
Managing Director
Vivek Paul
Senior Portfolio Strategist, BlackRock Investment Institute
Elga Bartsch
Head of Macro Research
Scott Thiel
Chief Fixed Income Strategist, BlackRock Investment Institute
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