For qualified investors

Fed catches up with restart reality

  • BlackRock

The Fed surprised markets by embracing higher inflation and heralding a lift-off from zero rates in 2023, rather than 2024. We think this could add to its new framework’s credibility as long as last week’s fall in inflation expectations does not persist. Ultimately, the Fed’s outlook implies a more muted response to rising inflation than in the past. This and the economic restart keep us pro-risk.

Key points

Midyear outlook forum
Fed officials embraced higher 2021 inflation as contributing to their medium-term policy objective, opening the door to a 2023 lift-off.
Market backdrop
We see this shift as consistent with the Fed’s new framework, implying a much more muted response to inflation and supporting risk assets.
Fed in focus
Global purchasing managers’ index (PMI) and other sentiment data this week will help investors gauge the status of the economic restart.
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Chart of the week
Average Fed inflation projections vs. catch-up inflation rates, 2005-2023

Average Fed inflation projections vs. catch-up inflation rates, 2005-2023

Sources: BlackRock Investment Institute, US Bureau of Economic Analysis and Federal Reserve, June 2021. Notes: The chart shows the range of actual core personal consumption expenditures (PCE) inflation levels that would be needed to make up for past undershoots of the Fed’s 2% target based on looking back at windows over the previous two and five years. The median projections for core PCE inflation for Q4 of 2021, 2022 and 2023 from the Fed’s Summary of Economic Projections (SEP) were 2.2, 2 and 2.1 respectively in March, and 3.0, 2.1 and 2.1 in June. The yellow lines represent the average of those projections in March and June.

The Fed has now made a meaningful upgrade to its inflation outlook by embracing a more pronounced overshoot of its 2% target. We view this upgrade as the Fed catching up with the restart dynamics. While the upgrade largely reflects the incoming data since the last meeting, there is a notable change: The Fed now sees the ongoing inflation surge as contributing to achieving its objective as opposed to focusing on its transitory nature. In addition, Fed officials now view the risks to their inflation outlook as having shifted to the upside. Even with the upgrade, their latest average inflation projection for the next three years only just sits at the bottom of the range of what could be argued to amount to a defendable make-up for past inflation undershoots. See the chart above. This new outlook opens the door to a 2023 liftoff in policy rates, something that was not possible under its March inflation outlook. This is still a much more muted response to inflation pressure than under its previous framework – or other major central banks’ current frameworks, in our view. It makes for a unique environment  - we have called it the New nominal – that we see playing out in the next few years.

Some market participants have suggested the Fed’s shift to acknowledge higher inflation and pull forward its rate hike projections is evidence that it is already retreating from its new framework. We don’t think that’s the case. Instead, we view it as a reflection of more positive longer-term dynamics. The inflation outlook upgrade can now be argued to support a meaningful make-up of past misses, as the chart shows. This gives greater credibility to the Fed’s current policy stance in the context of its new framework. But it’s a minimum requirement. The new framework implies that if inflation falls short of the Fed’s projections – which are just at the lower end of the catch-up rates – the Fed might have to delay lift-off. The credibility of the Fed’s new framework could become challenged if last week’s downward move in inflation expectations were to persist. Overall, we see the new guidance as more balanced, with meaningful risks on both sides.

We had expected a 2023 liftoff, and the Fed now projects two increases that year – versus no liftoff projected in March. Yet markets are getting ahead of themselves by baking in three rate increases by the end of 2023, as indicated by the pricing of futures tied to the cost of overnight borrowing, in our view. We believe there is a limit to how much more hawkish the Fed can be given its inflation projections relative to the catch-up rates range. If expectations for a much earlier lift-off were to take hold, that would call into question the credibility of the Fed’s new framework and could lead to broader risk-off sentiment. The Fed has flagged it will start to assess the economy’s progress meeting by meeting, and this means more “live” discussion on the tapering of its asset purchases. We would not view taper discussions as a signal that the liftoff is getting closer, yet there is a risk such discussions could trigger market volatility or be miscommunicated by the Fed.

Our bottom line: We believe the Fed’s new outlook will not translate into significantly higher policy rates any time soon. This, combined with the powerful restart, underpins our pro-risk stance. Large cash balances held by investors and no obvious signs of financial vulnerabilities give us additional confidence. We prefer to take risk in equities and remain underweight bonds on valuations. Within equities, we have been warming up to cyclical stocks as the restart broadens globally, as reflected in an overweight call on UK equities and our upgrading of European equities to neutral earlier this year. We may see bouts of market volatility as markets test the Fed’s resolve to stay “behind the curve” on inflation. Any temporary spikes in rates could challenge emerging market assets in particular, but we advocate staying invested and looking through any turbulence as the New nominal plays out.

A strong restart
The economic restart in the US is outpacing expectations. Read more in our macro insights.
Eyes on inflation

Assets in review
Selected asset performance, 2021 year-to-date and range

Selected asset performance in the past 12 months

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 17, 2021. Notes: The two ends of the bars show the lowest and highest returns at any point this 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, in descending order: spot Brent crude, MSCI Europe Index, MSCI USA Index, MSCI Emerging Markets Index, Bank of America Merrill Lynch Global High Yield Index, ICE US Dollar Index (DXY), spot gold, J.P. Morgan EMBI index, Refinitiv Datastream Italy 10-year benchmark government bond index, Bank of America Merrill Lynch Global Broad Corporate Index, Refinitiv Datastream Germany 10-year benchmark government bond index and Refinitiv Datastream US 10-year benchmark government bond index.

US consumer prices jumped in May and key drivers appear related to the activity restart. Stocks rallied to record highs and bond yields fell. Economic data have been erratic, and we expect more of the same as economies restart amid pent-up consumer demand and supply shortages. We advocate looking through near-term market volatility and remain pro-risk, predicated on our belief that the Fed faces a very high bar to change its easy monetary policy stance.

Week ahead

June. 22- Philly Fed nonmanufacturing business outlook survey
June. 23- Flash composite PMI for Japan, the euro area, UK and US
June. 24- Bank of England policy meeting; German ifo Business Climate Index
June. 25- US personal income and outlays

Global PMI and other sentiment data will help investors gauge the status of the economic restart. The restart has been broadening out thanks to accelerated vaccinations. It has also created both supply bottlenecks and pent-up consumer demand, leading to volatile near-term inflation and growth data especially in the US

Directional views

Strategic (long-term) and tactical (6-12 month) views on broad asset classes, May2021

Legend Granular

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 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, May2021

Legend Granular

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.

Read details about our investment themes and more in our 2021 Global outlook.

Growth edges up


We see the US and UK leading the developed world’s economic restart – with the euro area catching up - powered by pent-up demand and sky-high excess savings. The huge growth spurt will be transitory, in our view. This is because a restart is not a recovery: the more activity restarts now, the less there will be to restart later.

    • Fed officials in June projected higher inflation and moved up the lift-off in policy rates to 2023. We believe this confirmed our new nominal theme – that interest rates will rise more slowly than in the past in response to higher inflation – as the Fed’s acknowledgement of rising price pressures has not translated into projections for significantly higher interest rates any time soon.
    • We believe the rise in nominal government bond yields this year is justified and reflects markets awakening to a strong, vaccine-driven activity restart combined with historically large fiscal stimulus.
    • We expect short-term rates will stay anchored near zero, supporting equity valuations. The Fed could be more willing to lean against rising long-term yields than the past, yet the direction of travel over the next few years is clearly towards higher long-term yields. We see important limits on the level of yields the global economy can withstand.
    • Market implication: We favor inflation-linked bonds amid inflationary pressures in the medium term. Tactically we prefer to take risk in equities over credit amid low rates and tight spreads.
Policy Pause


Covid-19 has accelerated geopolitical transformations such as a bipolar US-China world order and a rewiring of global supply chains, placing greater weight on resilience.

    • The Biden administration is engaging in strategic competition with China, particularly on technology, and has criticized Beijing on human rights. Pending legislation in the US would direct large-scale investment to meet the China challenge. We see a case for greater exposure to China-related assets for potential returns and diversification – and view them as core strategic holdings that are distinct from EM exposures.
    • We expect persistent inflows to Asian assets as we believe many global investors remain underinvested and China’s weight in global indexes grows. Risks to China-exposed assets include China’s high debt levels and US-China conflicts, but we believe investors are compensated for these risks.
    • Momentum is growing at the G20 for a global minimum tax that would reduce the ability of multinationals to shift profits to low-tax jurisdictions.
    • Market implication: Strategically we favor deliberate country diversification and above-benchmark China exposures. Tactically we like Asia ex-Japan equities, and see UK equities as an inexpensive, cyclical exposure.
Raising resilience


The pandemic has added fuel to pre-existing structural trends such as an increased focus on sustainability, rising inequality within and across nations, and the dominance of e-commerce at the expense of traditional retail.

    • The pandemic has focused attention on underappreciated sustainability-related factors and supply chain resilience.
    • It has also accelerated “winner takes all” dynamics that have led to the strong performance of a handful of tech giants in recent years. We see tech as having long-term structural tailwinds despite its increased valuations, yet it could face challenges from higher corporate taxes and tighter regulation under a united Democratic government.
    • The pandemic has heightened the focus on inequalities within and across countries due to the varying quality of public health infrastructure – particularly across EMs – and access to healthcare. We see a risk of social unrest.
    • Market implication: Strategically we see returns being driven by climate change impacts, and view developed market equities as an asset class positioned to capture the opportunities from the climate transition. Tactically we favor tech and healthcare as well as selected cyclical exposures.
Jean Boivin
Head – BlackRock Investment Institute
Wei Li
Global Chief Investment Strategist – BlackRock Investment Institute
Elga Bartsch
Head of Macro Research — BlackRock Investment Institute
Scott Thiel
Chief Fixed Income Strategist -BlackRock Investment Institute

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