Macro outlook retakes spotlight
Weekly video_20230605
Alex Brazier
Opening frame: What’s driving markets? Market take
Camera frame
We think the U.S. debt ceiling deal removes a big near-term risk. But the deal will likely now thrust the market’s focus back to the underlying macro and debt backdrop.
Title slide: Macro outlook returns to forefront
We don’t see major central banks coming to the rescue with interest rate cuts this year, and we see rates staying higher for longer.
And we expect attention to turn to the broader government debt position in this new macro regime.
Here’s why:
1: What the debt deal means for inflation
We think an extremely tight labor market is the key factor keeping core inflation high.
And the spending cuts in the debt deal aren’t big, so they won’t stop that overheating. The Federal Reserve will have to keep interest rates high to bring inflation down.
2: Growing debt in the new regime
Higher rates mean higher debt servicing costs for the U.S. government.
And government spending has already well surpassed tax revenue by historic standards.
3: Risks for government bonds
We have long said that higher borrowing costs and heavy debt loads could cause investors to demand more compensation for holding long-term Treasuries.
And an influx of new Treasury bills to replenish government funds could add to volatility, especially for very short-dated bonds.
Outro frame: Here’s our Market take
We expand our preference for short-term bonds to encompass two-year Treasury notes.
We also like investment grade credit, emerging-market local currency debt and inflation-linked bonds.
Closing frame: Read details:
www.blackrock.com/weekly-commentary
Market focus to shift
We see the market’s focus returning to higher-for-longer rates and sticky inflation after a US debt ceiling deal. We prefer an up-in-quality portfolio.
Market backdrop
US stocks hit 2023 highs after the debt ceiling deal. Yields rose amid the specter of rate hikes after Friday’s payroll report showed a jump in new jobs.
Week ahead
China macro data is in focus this week. We trim our growth view slightly as the economic restart loses steam and policy reactions remain uncertain.
Last week’s US debt ceiling deal removes near-term uncertainty and thrusts the market’s focus back to the macro picture: sticky inflation due to tight labor markets. We see rates staying higher for longer as a result. We keep a quality tilt in portfolios and prefer income for now. Over time, we could see the attention shifting to the large US debt load – and investors demanding more compensation for holding long-term government bonds.
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Debt dilemma
US total public debt and budget balance, 2005-2023
Source: BlackRock Investment Institute with data from Federal Reserve Bank of St. Louis, Bureau of the Fiscal Service and Refinitiv Datastream, June 2023. Notes: The left chart shows total public debt and the right chart shows the US federal government budget balance, both as a share of GDP.
The US debt ceiling deal has taken the near-term risk of default off the table. Yet the fiscal situation remains challenging, in our view. Total public debt as a share of GDP has jumped to around double the level in 2005 (left chart). The budget deficit is also already large (right chart) at a time when the economy is overheating. The debt deal doesn’t really change this picture, we think. The spending cuts are a fraction of what was cut in the last debt ceiling showdown in 2011: about 0.3% of GDP, according to the Congressional Budget Office, compared with 1% in 2011. We don’t see spending cuts dragging on growth in the same way as a result. But we do think higher-for-longer interest rates will raise debt servicing costs and could leave debt levels growing in this new macro regime. We have said the market focus would move back to the macro picture after the debt ceiling deal – now the Federal Reserve and stubborn inflation are retaking the spotlight.
The pandemic shocked US labor supply, creating worker shortages. The labor market remains extremely tight, as confirmed in the latest payrolls data, with workforce participation not having improved. That is keeping core inflation sticky. This has presented the Fed with a sharp trade-off: crush growth with even higher rates or live with some inflation. We think the Fed will have to keep policy tighter. Markets have already started to mull the possibility of another rate hike even after the Fed signaled a potential pause. Markets are no longer pricing in repeated Fed rate cuts, waking up to our long-held view that rates are likely to stay higher for longer to combat persistent inflation.
High debt in the new regime
Attention could also eventually shift to the broader US fiscal position with rates staying higher, in our view. The relatively smaller spending cuts in the US debt ceiling deal aren't likely to put a dent in the debt load, in our view. They stand in stark contrast with the aftermath of the 2008 financial crisis when the focus swiftly shifted to fiscal austerity. Interest rates were near zero then and debt servicing costs were at record lows. But now rates have jumped in the fastest rate hiking cycle since the 1980s.
Higher rates mean higher debt servicing costs. We think persistent inflation and high debt levels could cause investors to demand more compensation for holding US assets over time, especially long-term Treasuries.
We also expect a burst of Treasury-bill issuance as the government seeks to replenish the money drawn down since the debt ceiling was hit earlier in the year. We estimate bill issuance could balloon to as much as $1 trillion in the next few months – well above normal issuance levels outside of past crises like the 2008 financial crisis and the pandemic. That could add to volatility in fixed income, in our view, especially in the very short-dated maturities. We tweak our preference for short-term Treasuries as a result, extending the preferred maturities beyond short-term paper to encompass two-year Treasury notes that have repriced in recent weeks.
Our bottom line
The US debt ceiling deal removes near-term uncertainty – we now expect markets to focus on the macro picture. We see higher-for-longer rates, so we keep our quality tilt in equities and bonds and prefer income for now. We like short-term Treasuries, emerging-market local currency debt and inflation-linked bonds.
Market backdrop
US stocks climbed to 2023 highs after the debt ceiling deal. Yields rose as markets eyed more rate hikes after Friday’s payroll report showed a jump in new jobs. The number of jobs added in May was well above market expectations. But the unemployment rate rose with no improvement in labor force participation. We don’t think the labor shortage is easing, so wage growth remains elevated. We think that will keep core inflation sticky – and makes rate cuts this year unlikely.
China macro data is in focus this week as the restart loses steam. We now expect GDP growth to be a bit below 6% this year rather than slightly above as momentum slows and policy reactions remain uncertain. Deflationary pressures and weaker growth increase the odds of potential policy easing, but we think targeted support for sectors like real estate is more likely.
Week ahead
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 Refinitiv Datastream as of June 1, 2023. Notes: The two ends of the bars show the lowest and highest returns at any point in the last 12-months, 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, Refinitiv 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.
June 5
China services PMI; US ISM services PMI
June 7
China trade data
June 9
China CPI and PPI
June 9-16
China total social financing
Read our past weekly commentaries here.
Investment themes
01
Pricing in the damage
Central banks are deliberately causing recession by overtightening policy to tame inflation, in our view. That makes recession foretold. What matters: our view on the pricing of economic damage and our assessment of market risk sentiment. Investment implication: We stay underweight DM equities but expect to turn more positive at some point in 2023.
02
Rethinking bonds
We see higher yields as a gift to investors long starved of income in bonds. And investors don’t have to go far up the fixed income risk spectrum to receive it. Investment implication: We like short-term government bonds, investment grade credit and agency mortgage-backed securities for income. We stay underweight long-term government bonds.
03
Living with inflation
Long-term trends of the new regime, such as aging workforces and geopolitical fragmentation, will keep inflation persistently above pre-pandemic levels, in our view. Investment implications: We stay overweight inflation-linked bonds on both tactical and strategic horizons. We are strategically overweight DM equities.
Directional views
Strategic (long-term) and tactical (6-12 month) views on broad asset classes, June 2023.
| Asset | Strategic view | Tactical view | Commentary |
|---|---|---|---|
| Equities |  |
 |
We are overweight equities in our strategic views as we estimate the overall return of stocks will be greater than fixed-income assets over the coming decade. Valuations on a long horizon do not appear stretched to us. Tactically, we’re underweight DM stocks as central banks’ rate hikes cause financial cracks and economic damage. Corporate earnings expectations have yet to fully reflect even a modest recession. We are overweight EM stocks and have a relative preference due to China’s restart, peaking EM rate cycles and a broadly weaker US dollar. |
| Credit |  |
|
Strategically, we are neutral global investment grade. We don’t think yields compensate investors for tightening credit conditions. We are neutral high yield as we see the asset class as more vulnerable to recession risks. Tactically, we’re neutral investment grade due to tightening credit and financial conditions. We’re underweight high yield as we see a recession coming and prefer to be up in quality. We’re overweight local-currency EM debt – we see it as more resilient with monetary policy tightening further along than in DMs. |
| Government bonds | |
|
We are neutral in our strategic view on government bonds. This reflects an overweight to short-term government bonds and max overweight to inflation-linked bonds. We stay underweight nominal long-term bonds: Markets are underappreciating the persistence of high inflation and investors likely demanding a higher term premium, in our view. Tactically, we’re underweight long-dated DM government bonds for the same reason. We favor short-dated government bonds – higher yields now offer attractive income with limited risk from interest rate swings. |
| Private markets | |
- | We’re underweight private growth assets and overweight on private credit from a starting allocation that is much larger than what most qualified investors hold. We find private credit yields more attractive than in public credit, and we like its floating-rate nature given our view that policy rates will remain higher for longer than markets expect. We think private credit can help fill a lending gap left by banks after sector turmoil. Overall, private assets are not immune to higher macro and market volatility or higher rates, and public market selloffs have reduced their relative appeal. Private allocations are long-term commitments, however, and we see opportunities as assets reprice over time. Private markets are a complex asset class not suitable for all investors. |
Note: Views are from a US 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.
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, June 2023.
| Asset | Tactical view | Commentary | ||
|---|---|---|---|---|
| Equities | ||||
| Developed markets | |
We are underweight. Earnings expectations and valuations don’t fully reflect recession risk. We prefer a sectoral approach: energy and healthcare. | ||
| United States | |
We are underweight. Financial cracks are emerging from Fed rate hikes. We don’t think earnings expectations reflect the recession we see ahead. | ||
| Europe | |
We are underweight. The impact of higher interest rates and elevated inflation pose a challenge for earnings, even as the energy shock fades. | ||
| U.K. | |
We are underweight. We find valuations expensive after their strong relative performance versus other developed markets thanks to energy sector exposure. | ||
| Japan | |
We are underweight. The Bank of Japan looks set to wind down its ultra-loose policy. Japan is exposed to the weaker activity we see in other DM economies. | ||
| Emerging markets | |
We are overweight and have a relative preference over DM stocks due to China’s powerful restart, peaking EM rate cycles and a broadly weaker US dollar. | ||
| China | |
We see short-term opportunities from China’s restart. But geopolitical risks have risen, and we still see long-term, structural challenges and risks. | ||
| Asia ex-Japan | |
We are neutral. China’s near-term cyclical rebound is a positive, yet we don’t see valuations compelling enough to turn overweight. | ||
| Fixed income | ||||
| Long US Treasuries | |
We are underweight. We see long-term yields moving up further as investors demand a greater term premium. | ||
| Short US Treasuries |  |
We are overweight. We prefer short-term government bonds for income as interest rates stay higher for longer.. | ||
| Global inflation-linked bonds | |
We are overweight. We see market pricing underestimating the risk of persistently higher inflation. | ||
| European government bonds | |
We are underweight. We see investors demanding greater term premium, with peripheral bonds at risk from tighter financial conditions. | ||
| UK Gilts | |
We are neutral. We find gilt yields attractive as they have risen back near levels reached during 2022’s budget turmoil. We prefer short-dated gilts for income. | ||
| China government bonds | |
We are neutral. We find their yield levels less attractive than those on DM short-term government bonds. | ||
| Global investment grade credit | |
We are neutral. We see tighter credit and financial conditions. We prefer European investment grade over the US given more attractive valuations. | ||
| US agency MBS | |
We’re neutral. We see agency MBS as a high-quality exposure within diversified bond allocations. But spreads near long-term averages look less compelling. | ||
| Global high yield | |
We are underweight. We think spreads are still too tight, given our expectation for tighter credit and financial conditions – and an eventual recession. | ||
| Emerging market - hard currency | |
We are neutral. We see support from higher commodities prices yet it is vulnerable to rising US yields. | ||
| Emerging market - local currency | |
We are overweight due to China’s restart, and we see EM debt as more resilient to tightening financial conditions than DM as EM hiking cycles near peaks. | ||
| Asia fixed income | |
We are neutral. We don’t find valuations compelling enough yet to turn more positive. | ||
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. 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, June 2023.
| Asset | Tactical view | Commentary | ||
|---|---|---|---|---|
| Equities | ||||
| Europe ex UK | |
We are underweight. We don’t think consensus earnings expectations are pricing in heightened risks of a deep recession. We see a sharp hit to euro area growth from the energy price shock alone. The European Central Bank looks intent on squeezing out inflation via policy overtightening, making a recession likely. | ||
| Germany | |
Valuations are supportive relative to peers, but near-term headwinds to earnings prospects remain significant. They include uncertainty on energy supply, rapid ECB tightening and slower growth in major trading partners. Looking further ahead, opportunities may arise from political ambitions to bring the economy to net zero. | ||
| France | |
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, favorable energy mix and boost to the luxury sector from China's near-term reopening. | ||
| Italy | |
While valuations and earnings trends are attractive versus peers, the economy’s relatively weak credit fundamentals amid a global tightening financial conditions keep us cautious. | ||
| Spain | |
The market’s outperformance in 2022 – driven largely by its greater relative exposure to rate-sensitive financials – leaves it vulnerable to profit-taking amid a broader, regional downturn, in our view. | ||
| Netherlands | |
The earnings outlook has weakened more than in other European markets, resulting in a negative earnings outlook over the next 12 months. Dutch stocks are trading at a comparable valuation but offer a relatively low dividend yield. | ||
| Switzerland | |
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 | |
We are underweight. We see UK activity contracting as explicitly acknowledged by the Bank of England – and yet not reflected in consensus earnings expectations. The market has outperformed other DMs in 2022 due to energy sector exposure flattered by a weaker currency – and is not immune to a global downturn. | ||
| Fixed income | ||||
| Euro area government bonds | |
We are underweight. We expect the ECB to keep tightening even after the recession has started. Global trend of higher term premium being priced in should also push long term yields up. We see inflation coming down to target only very slowly and tight monetary policy remains a risk to peripheral spreads. | ||
| German bunds | |
The ECB is likely to keep overtightening policy even after a recession starts, while inflation is likely to return close target only very slowly. The new investment regime of higher macro volatility globally should translate into higher risk premia for holding long term government bonds, a trend from which Germany will struggle to decouple from. | ||
| French OATs | |
We are neutral. Valuations look 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 | |
BTP-Bund spread is too tight given the weakening in Italy’s credit fundamentals and a now negative current account balance. Yet a relatively prudent fiscal stance from the new government should keep any spread widening limited, with investors compensated by the higher carry of Italian government bonds. | ||
| Swiss government bonds | |
We prefer Swiss bonds relative to euro area bonds. The Swiss National Bank has quickly hiked policy rates back to positive. Further upward pressure on yields appears limited given global macro uncertainty, still relatively subdued underlying inflation and a strong currency. We don’t see the SNB hiking rates as much as the ECB. | ||
| UK gilts | |
We are neutral. We find gilt yields attractive as they have risen back near levels reached during 2022’s budget turmoil. We prefer short-dated gilts for income. | ||
| European inflation-linked bonds | |
We turn neutral. We see euro area inflation falling to the ECB target over a multi-year period, supporting breakeven pricing, but policy tightening into a recession is a headwind to the asset class. | ||
| European investment grade credit | |
We are overweight European investment-grade credit. We still find valuations attractive in terms of both overall yield and the spread, especially when considering the lower duration compared with US credit. | ||
| European high yield | |
We are neutral. We find the income potential attractive, yet prefer up-in-quality credit exposures amid a worsening macro backdrop. | ||
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, June 2023. 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.
Jean Boivin
Head – BlackRock Investment Institute
Wei Li
Global Chief Investment Strategist – BlackRock Investment Institute
Alex Brazier
Deputy Head – BlackRock Investment Institute
Nicholas Fawcett
Macro Research – BlackRock Investment Institute
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