Market insights

Weekly market commentary

30-Jan-2023
  • BlackRock Investment Institute

Higher rates reinforce income’s appeal

Market take

Weekly video_20230130

Nicholas Fawcett

Opening frame: What’s driving markets? Market take

Camera frame

The Federal Reserve and European Central Bank are set to raise rates again this week to fight inflation.

Title slide: Rate hikes reinforce why yield is back

But markets are pricing rate cuts in 2023 even as both central banks insist that they will stay the course.

1: Policy rates higher for longer

We see the disconnect resolving in favor of central banks.

Inflation is set to fall a lot – but not all the way to 2% in our view.

Like central banks – we are looking for wage pressures to sustainably subside. They’ll want to see this before declaring victory on inflation – so rate cuts are a long way off.

2: Risks underpinning higher long-term yields

That’s one reason we prefer short-term bonds. Another is that we see investors demanding more to hold long-term bonds.

That might happen if the Bank of Japan changes its yield curve control policy and that causes market dislocations.

That may also happen amid the tussle to lift the U.S. debt ceiling, though we do expect negotiations to be resolved.

3: Opportunity in short-term fixed income

Short-term government bonds and investment grade credit now offer some of the highest yields in the last two decades.

We prefer them for income. We also like agency mortgage-backed-securities to diversify income.

Global investment grade credit offers even more yield than short-term bonds, and should weather a downturn.

Outro frame: Here’s our Market take 

We like short-term government bonds and high-grade credit for their income potential.

Closing frame: Read details: 

www.blackrock.com/weekly-commentary

General disclosure:  This material is intended for information purposes only, and does not constitute investment advice, a recommendation or an offer or solicitation to purchase or sell any securities to any person in any jurisdiction in which an offer, solicitation, purchase or sale would be unlawful under the securities laws of such jurisdiction. This material may contain estimates and forward-looking statements, which may include forecasts and do not represent a guarantee of future performance. This information is not intended to be complete or exhaustive and no representations or warranties, either express or implied, are made regarding the accuracy or completeness of the information contained herein. The opinions expressed are as of January 2023 and are subject to change without notice. Reliance upon information in this material is at the sole discretion of the reader. Investing involves risks.

In the U.S. and Canada, this material is intended for public distribution. In the European Economic Area (EEA):  this is Issued by BlackRock (Netherlands) B.V. is authorised and regulated by the Netherlands Authority for the Financial Markets. Registered office Amstelplein 1, 1096 HA, Amsterdam, Tel: 020 – 549 5200, Tel: 31-20-549-5200. Trade Register No. 17068311 For your protection telephone calls are usually recorded. In the UK and Non-European Economic Area (EEA) countries: this is Issued by BlackRock Advisors (UK) Limited, which is authorised and regulated by the Financial Conduct Authority. Registered office: 12 Throgmorton Avenue, London, EC2N 2DL, Tel: +44 (0)20 7743 3000. Registered in England and Wales No. 00796793. For your protection, calls are usually recorded. Please refer to the Financial Conduct Authority website for a list of authorised activities conducted by BlackRock. For qualified investors in Switzerland: This document is marketing material. This document shall be exclusively made available to, and directed at, qualified investors as defined in Article 10 (3) of the CISA of 23 June 2006, as amended, at the exclusion of qualified investors with an opting-out pursuant to Art. 5 (1) of the Swiss Federal Act on Financial Services (FinSA). For information on art. 8 / 9 Financial Services Act (FinSA) and on your client segmentation under art. 4 FinSA, please see the following website: www.blackrock.com/finsa. For investors in Israel: BlackRock Investment Management (UK) Limited is not licensed under Israel’s Regulation of Investment Advice, Investment Marketing and Portfolio Management Law, 5755-1995 (the Advice Law), nor does it carry insurance thereunder. In South Africa, please be advised that BlackRock Investment Management (UK) Limited is an authorized financial services provider with the South African Financial Services Board, FSP No. 43288. In the DIFC this material can be distributed in and from the Dubai International Financial Centre (DIFC) by BlackRock Advisors (UK) Limited — Dubai Branch which is regulated by the Dubai Financial Services Authority (DFSA). This material is only directed at 'Professional Clients’ and no other person should rely upon the information contained within it. Blackrock Advisors (UK) Limited - Dubai Branch is a DIFC Foreign Recognised Company registered with the DIFC Registrar of Companies (DIFC Registered Number 546), with its office at Unit 06/07, Level 1, Al Fattan Currency House, DIFC, PO Box 506661, Dubai, UAE, and is regulated by the DFSA to engage in the regulated activities of ‘Advising on Financial Products’ and ‘Arranging Deals in Investments’ in or from the DIFC, both of which are limited to units in a collective investment fund (DFSA Reference Number F000738) In the Kingdom of Saudi Arabia,  issued in the Kingdom of Saudi Arabia (KSA) by BlackRock Saudi Arabia (BSA), authorised and regulated by the Capital Market Authority (CMA), License No. 18-192-30. Registered under the laws of KSA. Registered office: 29th floor, Olaya Towers – Tower B, 3074 Prince Mohammed bin Abdulaziz St., Olaya District, Riyadh 12213 – 8022, KSA, Tel: +966 11 838 3600. The information contained within is intended strictly for Sophisticated Investors as defined in the CMA Implementing Regulations. Neither the CMA or any other authority or regulator located in KSA has approved this information. The information contained within, does not constitute and should not be construed as an offer of, invitation or proposal to make an offer for, recommendation to apply for or an opinion or guidance on a financial product, service and/or strategy. Any distribution, by whatever means, of the information within and related material to persons other than those referred to above is strictly prohibited. In the United Arab Emirates is only intended for -natural Qualified Investor as defined by the Securities and Commodities Authority (SCA) Chairman Decision No. 3/R.M. of 2017 concerning Promoting and Introducing Regulations. Neither the DFSA or any other authority or regulator located in the GCC or MENA region has approved this information. In the State of Kuwait, those who meet the description of a Professional Client as defined under the Kuwait Capital Markets Law and its Executive Bylaws. In the Sultanate of Oman, to sophisticated institutions who have experience in investing in local and international securities, are financially solvent and have knowledge of the risks associated with investing in securities. In Qatar, for distribution with pre-selected institutional investors or high net worth investors.  In the Kingdom of Bahrain, to Central Bank of Bahrain (CBB) Category 1 or Category 2 licensed investment firms, CBB licensed banks or those who would meet the description of an Expert Investor or Accredited Investors as defined in the CBB Rulebook. The information contained in this document, does not constitute and should not be construed as an offer of, invitation, inducement or proposal to make an offer for, recommendation to apply for or an opinion or guidance on a financial product, service and/or strategy.  In Singapore, this is issued by BlackRock (Singapore) Limited (Co. registration no. 200010143N). This advertisement or publication has not been reviewed by the Monetary Authority of Singapore.  In Hong Kong, this material is issued by BlackRock Asset Management North Asia Limited and has not been reviewed by the Securities and Futures Commission of Hong Kong. In South Korea, this material is for distribution to the Qualified Professional Investors (as defined in the Financial Investment Services and Capital Market Act and its sub-regulations). In Taiwan, independently operated by BlackRock Investment Management (Taiwan) Limited. Address: 28F., No. 100, Songren Rd., Xinyi Dist., Taipei City 110, Taiwan. Tel: (02)23261600. In Japan, this is issued by BlackRock Japan. Co., Ltd. (Financial Instruments Business Operator: The Kanto Regional Financial Bureau. License No375, Association Memberships: Japan Investment Advisers Association, the Investment Trusts Association, Japan, Japan Securities Dealers Association, Type II Financial Instruments Firms Association.) For Professional Investors only (Professional Investor is defined in Financial Instruments and Exchange Act). In Australia, issued by BlackRock Investment Management (Australia) Limited ABN 13 006 165 975 AFSL 230 523 (BIMAL). The material provides general information only and does not take into account your individual objectives, financial situation, needs or circumstances. In China, this material may not be distributed to individuals resident in the People’s Republic of China (PRC, for such purposes, excluding Hong Kong, Macau and Taiwan) or entities registered in the PRC unless such parties have received all the required PRC government approvals to participate in any investment or receive any investment advisory or investment management services. For Other APAC Countries, this material is issued for Institutional Investors only (or professional/sophisticated /qualified investors, as such term may apply in local jurisdictions). In Latin America, no securities regulator within Latin America has confirmed the accuracy of any information contained herein. The provision of investment management and investment advisory services is a regulated activity in Mexico thus is subject to strict rules. For more information on the Investment Advisory Services offered by BlackRock Mexico please refer to the Investment Services Guide available at www.blackrock.com/mx

©2023 BlackRock, Inc. All Rights Reserved. BLACKROCK is a trademark of BlackRock, Inc., or its subsidiaries in the United States and elsewhere. All other trademarks are those of their respective owners.

Favoring fixed income

We don’t see major central bank rate cuts this year, so we prefer to earn income in short-term bonds, high-grade credit and agency mortgage-backed securities.

Market backdrop

US stocks rose and Treasury yields were mostly steady. US Q4 GDP was resilient but declining consumer spending suggests growth is slowing quickly.

Week ahead

The Fed and the European Central Bank anchor policy decisions this week. We see them hiking and holding rates higher for longer than markets expect.

Major central banks are set to hike policy rates again this week and keep them higher, counter to market views for cuts this year. We see this disconnect resolving and favoring higher rates. That’s because we think inflation will fall fast but stay above target. Rates staying high plus the political tussle over raising the US borrowing limit are market risks. We prefer to earn income and like short-term government bonds, high-grade credit and mortgage-backed securities.

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

Chart of the week

Yield is back

Investment grade and short-term government debt yields, 2002-2022

The chart shows that yields for two-year U.S. Treasury bonds, represented by a yellow line, and investment grade credit, represented by a red line, have spiked since 2022 to some of the highest levels in last two decades.

Source: BlackRock Investment Institute, with data from Refinitiv, January 2023. Notes: The chart shows yields for the Bloomberg Global Aggregate Corporate Index and benchmark two-year US Treasuries.

Income is finally back in fixed income thanks to higher yields and coupons. Short-term government bonds and investment grade (IG) credit now offer some of the highest yields in the last two decades. See the chart. We prefer to earn income right now from these high-quality fixed income assets as rates rise and stay high. Fixed income’s appeal remains intact the longer central banks keep rates near their peak. The lack of duration – or the sensitivity of bond prices to interest rates – in short-term paper also helps preserve income even if yields rise anew. Global IG credit offers high-grade, liquid income – and we think the strong balance sheets of high-quality companies that refinanced debt at lower rates can weather the mild recession we see ahead. We also like agency mortgage-backed securities (MBS) to diversify income.

We see major central banks on a path to overtighten policy because they’re worried about the persistence of underlying core inflation, excluding food and energy prices. PCE data in the US confirmed the outlook for core inflation hasn’t improved, and it’s tracking to be well above policy targets into 2024. Core services inflation is proving sticky even as goods prices fall. That stickiness is tied to wage pressures in the labor market that we see remaining tight. We think central banks will want more evidence that core inflation and wage pressures are sustainably subsiding before they declare victory on inflation and think about easing policy. This will take a long time – and is unlikely to happen this year, in our view.

This week, the Fed and ECB are set to push rates further up again. We see the Fed hiking 0.25% and the ECB raising 0.5%, with more hikes likely to follow. Then we see them keeping rates high. But markets are pricing rate cuts in 2023 even as both central banks insist they will stay the course. That disconnect needs to be resolved, and we think it will be in favor of higher rates as inflation persists above central banks’ 2% target. Rates staying high is one reason we prefer earning income with shorter duration paper.

Another reason is term premium – the compensation investors demand for holding long-term government bonds. We see investors seeking more term premium with higher inflation and other near-term risks on the horizon. Political pressure on the Bank of Japan to change its yield curve control policy is likely to ramp up with inflation running at a four-decade high. The risk: a global spillover from higher Japanese government bond yields to global yields. We think moving away from yield curve control would be like a move away from a currency peg – even tweaks could lead to abrupt market dislocations.

Risks over raising the US borrowing cap are also in focus now after the US hit its debt ceiling this month – this reinforces our view that investors will once again demand term premium. Negotiations are likely to go down to the wire this summer and could be as fraught as 2011, when S&P Global downgraded the US triple-A credit rating. We ultimately expect a resolution. If a US default were to occur, it would likely be technical in nature, meaning the US would prioritize debt payments over other obligations. We would expect only a temporary rise in selected Treasury bill yields as the default date nears. Another debt ceiling impasse could also pressure risk assets as in past episodes – this keeps us cautious on US equities.

Our bottom line:

Rates staying high and the political tussle over the US debt ceiling are market risks. We take a granular view on fixed income at this juncture. We tactically like short-term government bonds, high-grade credit and agency mortgage-backed securities for attractive income.

Market backdrop

US stocks climbed and bond yields were mostly steady, with European and emerging market shares outperforming the US on investor inflows. US GDP was resilient in the last quarter of 2022. Consumer spending helped prop up growth, but we see signs of weakness beneath the surface. The US PCE data showed consumer spending was losing momentum at the end of the year and suggests that growth is slowing more quickly than we expected.

The Fed and the European Central Bank anchor this week’s central bank decisions. We see them both pushing up rates further and pushing back against market expectations for rate cuts. The US services PMI and payrolls data will give the latest view on recession risks. We think further resilience in activity and the labor market could embolden the Fed.

Week ahead

The chart shows that the U.S. dollar index is the best performing asset at any point in the last 12-months among a selected group of assets, while the Italian 10-year BTP 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 Refinitiv Datastream as of Jan. 26, 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 12-month 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.

Jan. 31

Euro area flash Q4 GDP; US consumer confidence

Feb. 1

Fed policy decision; US job openings; euro area inflation

Feb. 2

European Central Bank, Bank of England policy decisions

Feb. 3

US payrolls, US ISM services PMI; China services PMI

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, January 2023. 

Legend Granular

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, January 2023.

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 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, January 2023. 

Legend Granular

Asset Tactical view Commentary
Equities
 Europe ex UK Europe ex-UK: tactical Underweight -1 We are underweight European equities. 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 higher rates – another drag on activity.
Germany Germany: tactical Underweight -1 We are neutral German equities. While valuations are supportive relative to peers, near-term headwinds to earnings prospects remain significant amid tense gas supplies, rapid ECB tightening and slower growth of major trading partners. Looking further ahead, opportunities arise from political ambitions to bring the economy to net zero.
France France: tactical Underweight -1 We are underweight French equities. France’s more favourable energy mix and the stock market’s tilt to energy could help insulate portfolios against elevated inflation. High electricity prices put pressure on corporate margins, though, despite policy relief. The pace of structural reforms looks set to slow following the parliamentary elections.
Italy Italy: tactical Underweight -1 We are underweight Italian equities. The economy’s relatively weak credit fundamentals amid tightening financial conditions globally keep us cautious.
Spain Spain: tactical Underweight -1 We are underweight Spanish equities. The market’s outperformance in 2022 – driven largely by its greater relative exposure to rate-sensitive financials – leave it vulnerable, in our view, to profit-taking amid a broader, regional downturn on slowing growth.
Netherlands Netherlands: tactical Underweight -1 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 UK: tactical neutral We are neutral Swiss equities. The equity benchmark sports a defensive tilt with high sector weights to health care and consumer goods, providing a cushion amid heightened uncertainty over the global macro outlook.
UK UK: underweight -1 We are underweight UK equities. We see UK growth slowing sharply – as explicitly acknowledged by the Bank of England and yet not reflected in consensus earnings expectations. The market – that has outperformed other DMs in 2022 due to energy sector exposure – is not immune to a global downturn.
Fixed income
Euro area government bonds Euro area government bonds: tactical Neutral We are neutral nominal European government bonds. Market pricing of ECB policy is too hawkish, we think, given looming recession. The end of ECB net asset purchases, likely issuance to support fiscal policies and our view of elevated inflation keeps us from turning positive and underpins our preference for inflation-linked bonds.
German bunds German bunds: tactical Neutral Weare neutral German bunds. Further upward pressure on yields appears limited to us given hawkish ECB policy expectations even with rising recessionary risks, elevated – yet possibly peaking – headline inflation, and lingering geopolitical uncertainty.
French OATs French OATs: tactical Underweight -1 Elevated French public debt and a slower pace of structural reforms remain negatives even as French spreads to German bonds are above historical averages.
Italian BTPs Italian BTPs: tactical Underweight -1 We have a modest underweight on Italian BTPs. Spreads have already widened this year, yet we stay cautious given weaker credit fundamentals, global policy tightening and lingering political uncertainty. The ECB’s Transmission Protection Instrument – a bond purchase scheme – offers a backstop.
Swiss government bonds Swiss government bonds: tactical Neutral We are neutral Swiss bonds. The Swiss National Bank has quickly moved its policy rate into positive territory despite the highly valued Franc. Further upward pressure on yields appears limited, though, in light of lingering uncertainties and still comparatively subdued underlying inflation pressure.
UK gilts Swiss government bonds: tactical Neutral We are neutral UK gilts. Perceptions of fiscal credibility have improved, though not fully, after a reversal of planned fiscal stimulus. We think the BoE will have to hike rates less than we assumed immediately after the Sept. 23 “mini budget.”
European inflation-protected securities European inflation-protected securities: tactical Overweight +1 We are overweight European inflation-protected government bonds because we see persistent inflation and the ECB ultimately living with higher levels of it. Weaning off Russian fossil fuels is likely to keep energy inflation high in the medium term. The short-term impact will be even more severe if Russia cuts off the gas supply.
European investment grade credit European investment grade credit: tactical Overweight +1 We are overweight investment-grade credit. We find valuations attractive in terms of both overall yield and the spread vs. government bonds. Coupon income is the highest in about a decade.
European high yield European high yield: tactical Neutral We are neutral high yield. 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, October 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.

Wei Li
Global Chief Investment Strategist – BlackRock Investment Institute
Alex Brazier
Deputy Head – BlackRock Investment Institute
Kurt Reiman
Senior Strategist for North America – BlackRock Investment Institute
Nicholas Fawcett
Macro research – 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.

© 2022 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.