INSIGHTS & VIEWS
INVESTMENT INSIGHTS
Our thought leadership in investing, risk management, portfolio construction and trading solutions.
Please read this page before proceeding as it explains certain restrictions imposed by law on the distribution of this information and the jurisdictions in which our products and services are authorised to be offered or sold.
By entering this site, you are agreeing that you have reviewed and agreed to the terms contained herein, including any legal or regulatory restrictions, and have consented to the collection, use and disclosure of your personal data as set out in the Privacy section referred to below.
By confirming below, you also acknowledge that you:
(i) have read this important information;
(ii) agree your access to this website is subject to the disclaimer, risk warnings and other information set out herein; and
(iii) are the relevant sophistication level and/or type of audience intended for your respective country or jurisdiction identified below.
The information contained on this website (this “Website”) (including without limitation the information, functions and documents posted herein (together, the “Contents”) is made available for informational purposes only.
No Offer
The Contents have been prepared without regard to the investment objectives, financial situation, or means of any person or entity, and the Website is not soliciting any action based upon them.
This material should not be construed as investment advice or a recommendation or an offer or solicitation to buy or sell securities and does not constitute an offer or solicitation in any jurisdiction where or to any persons to whom it would be unauthorized or unlawful to do so.
Access Subject to Local Restrictions
The Website is intended for the following audiences in each respective country or region: In the U.S.: public distribution. In Canada: public distribution. In the UK and outside the EEA: 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. In the EEA, professional clients, qualified clients, and qualified investors. For qualified investors in Switzerland, qualified investors as defined in the Swiss Collective Investment Schemes Act of 23 June 2006, as amended. In DIFC: 'Professional Clients’ and no other person should rely upon the information contained within it. In Singapore, public distribution. In Hong Kong, public distribution. In South Korea, Qualified Professional Investors (as defined in the Financial Investment Services and Capital Market Act and its sub-regulations). In Taiwan, Professional Investors. In Japan, Professional Investors only (Professional Investor is defined in Financial Instruments and Exchange Act). In Australia, public distribution. In China, this 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, Institutional Investors only (or professional/sophisticated /qualified investors, as such term may apply in local jurisdictions). In Latin America, institutional investors and financial intermediaries only (not for public distribution).
This Contents are not intended for, or directed to, persons in any countries or jurisdictions that are not enumerated above, or to an audience other than as specified above.
This Website has not been, and will not be submitted to become, approved/verified by, or registered with, any relevant government authorities under the local laws. This Website is not intended for and should not be accessed by persons located or resident in any jurisdiction where (by reason of that person's nationality, domicile, residence or otherwise) the publication or availability of this Website is prohibited or contrary to local law or regulation or would subject any BlackRock entity to any registration or licensing requirements in such jurisdiction.
It is your responsibility to be aware of, to obtain all relevant regulatory approvals, licenses, verifications and/or registrations under, and to observe all applicable laws and regulations of any relevant jurisdiction in connection with your access. If you are unsure about the meaning of any of the information provided, please consult your financial or other professional adviser.
No Warranty
The Contents are published in good faith but no advice, representation or warranty, express or implied, is made by BlackRock or by any person as to its adequacy, accuracy, completeness, reasonableness or that it is fit for your particular purpose, and it should not be relied on as such. The Contents do not purport to be complete and is subject to change. You acknowledge that certain information contained in this Website supplied by third parties may be incorrect or incomplete, and such information is provided on an "AS IS" basis. We reserve the right to change, modify, add, or delete, any content and the terms of use of this Website without notice. Users are advised to periodically review the contents of this Website to be familiar with any modifications. The Website has not made, and expressly disclaims, any representations with respect to any forward-looking statements. By their nature, forward-looking statements are subject to numerous assumptions, risks and uncertainties because they relate to events and depend on circumstances that may or may not occur in the future.
No information on this Website constitutes business, financial, investment, trading, tax, legal, regulatory, accounting or any other advice. If you are unsure about the meaning of any information provided, please consult your financial or other professional adviser.
No Liability
BlackRock shall have no liability for any loss or damage arising in connection with this Website or out of the use, inability to use or reliance on the Contents by any person, including without limitation, any loss of profit or any other damage, direct or consequential, regardless of whether they arise from contractual or tort (including negligence) or whether BlackRock has foreseen such possibility, except where such exclusion or limitation contravenes the applicable law.
You may leave this Website when you access certain links on this Website. BlackRock has not examined any of these websites and does not assume any responsibility for the contents of such websites nor the services, products or items offered through such websites.
Intellectual Property Rights
Copyright, trademark and other forms of proprietary rights protect the Contents of this Website. All Contents are owned or controlled by BlackRock or the party credited as the provider of the Content. Except as expressly provided herein, nothing in this Website should be considered as granting any licence or right under any copyright, patent or trademark or other intellectual property rights of BlackRock or any third party.
This Website is for your personal use. As a user, you must not sell, copy, publish, distribute, transfer, modify, display, reproduce, and/or create any derivative works from the information or software on this Website. You must not redeliver any of the pages, text, images, or content of this Website using "framing" or similar technology. Systematic retrieval of content from this Website to create or compile, directly or indirectly, a collection, compilation, database or directory (whether through robots, spiders, automatic devices or manual processes) or creating links to this Website is strictly prohibited. You acknowledge that you have no right to use the content of this Website in any other manner.
Additional Information
Investment involves risks. Past performance is not a guide to future performance. 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.
Privacy
Your name, email address and other personal details will be processed in accordance with BlackRock’s Privacy Policy for your specific country which you may read by accessing our website at https://www.blackrock.com.
Please note that you are required to read and accept the terms of our Privacy Policy before you are able to access our websites.
Once you have confirmed that you agree to the legal information herein, and the Privacy Policy – by indicating your consent – we will place a cookie on your computer to recognise you and prevent this page from reappearing should you access this site, or other BlackRock sites, on future occasions. The cookie will expire after six months, or sooner should there be a material change to this important information.
We've entered an era where supply constraints are the driving force of inflation rather than excess demand. This will likely bring more macro volatility and force policymakers to live with higher inflation.
We are in a new and unusual market regime, underpinned by a new macro landscape where inflation is shaped by supply constraints. Limits on supply have driven the surge in inflation over the past year: a profound change from the decades-long dominance of demand drivers. This fundamentally changes how we should think about the macro environment and the market implications. The key to understanding the muted response of central banks to inflation is not the timeframe but its cause: supply. Much of the 2021 debate overlooked this.
Economy-wide and sector-specific supply constraints are at play in the economic restart – these are pushing inflation higher, even though overall economic activity has not fully recovered. The restart gives a glimpse of how the transition to net-zero emissions will play out: it will be akin to a drawn-out restart with both economy-wide supply limits and big shifts across sectors creating supply bottlenecks. Whether or not carbon emissions are reduced, we believe climate change will increase inflation. An orderly transition to net-zero is the least inflationary path, in our view.
In addition, a rewiring of globalization and population ageing in China are reducing the supply of cheap imports from China to developed markets. This will raise costs and force further resource reallocation in those markets, making supply constraints more common. Geopolitical risks threaten to disrupt energy supply.
A world shaped by supply constraints will bring more macro volatility. Monetary policy cannot stabilize both inflation and growth: it has to choose between them. We think central banks should live with supply-driven inflation, rather than destroy demand and economic activity – provided inflation expectations remain anchored. When inflation is the result of sectoral reallocation, accommodating it yields better outcomes, as recent research (Guerrieri et al, 2021) shows. Insisting on stabilizing inflation would lead to an overtightening of monetary policy, more activity sacrificed and a slowing down of the needed sectoral reallocation.
This – together with the policy revolution that we will come back to in a follow-up publication – is why we expect the sum total of rate hikes in this cycle to be low. Central banks will take their foot off the gas by starting to remove stimulus – but they shouldn’t go further to fight inflation, in our view. We consider the risks to this view and the investment implications.
This new era of supply-driven inflation has been ushered in by the Covid-19 pandemic shutdowns and the economic restart that followed. The start of the pandemic was dominated by an economy-wide supply shock: activity was deliberately brought to a halt to curb the spread of the virus. As restrictions were lifted and the powerful restart took hold, it proved difficult to bring production back online as quickly.
Through 2021 the restart saw the emergence of more sector-specific supply problems, driven by the sudden and sharp shift in consumer spending away from services and towards goods. This shift in the mix of demand created bottlenecks in goods-producing sectors as supply struggled to keep pace. Meanwhile, it created spare capacity in service industries. This has driven inflationary pressure in goods sectors, which have seen the largest price rises – see the chart below.
In service sectors that have lost out from the shift in spending, prices have been stickier, despite perhaps needing to fall. This is typical, but in the restart it has been reinforced by another supply constraint. Normally, sectors that are losing out tend to see lower wage growth. But due to the pandemic, people have left the labor force, particularly those that were in contact-intense services like leisure and hospitality. So, service sector companies faced with the shift in spending away from them have – unusually – been faced with rising, not falling, wage costs in their industries.
Some have attributed current high inflation to greater fiscal spending in the U.S. We see it as a contributing factor, not the primary cause. This is not a classic case of overall demand in the economy – supported by fiscal policy – being unusually high. Fiscal policy cannot explain why inflation is so high when economic activity has yet to fully recover. The fundamental constraint is that supply capacity is unusually low. This is yet another way in which this restart differs from a normal cyclical recovery. The way to deal with this inflation, in our view, is not to destroy demand, but to increase supply capacity and promote the movement of resources across sectors.
Major spending shift
U.S. goods vs. services inflation and spending, 2005-2021
Sources: BlackRock Investment Institute, U.S. Bureau of Labor Statistics, with data from Haver Analytics, January 2022. Notes: The chart shows core goods and services CPI inflation, the green line shows the share of nominal goods spending in total U.S. personal consumer spending.
We believe the economic restart provides a glimpse of what is to come. The transition to net-zero will be like a restart drawn out over decades, bringing with it new supply constraints that push up inflation – through both broad-based and sectoral channels.
The transition is fundamentally about including the costs of climate damages in economic decisions. These costs can be reflected in different ways: carbon taxes, regulations or just consumers choosing to pay more to avoid climate damages. Regardless of how the cost is internalized, we see a broad-based impact on inflation: energy costs are likely to increase, driving up producer and consumer prices. How that translates into inflation depends on the timeframe over which those increases occur. A smooth, even transition would spread out the impact. If the shift happens faster – condensing prices rises into a shorter timeframe – the impact on inflation would be more material.
In addition, the restart shows how another often overlooked channel will operate in the transition. Supply constraints will be caused by reallocation across sectors, in this case to accommodate shifting energy demands. In their World Economic Outlook,
the IMF suggests that over 2% of global employment will ultimately need to change sector to meet these demands – see the chart. If demand shifts faster than resources are reallocated, the mismatch could push overall inflation higher – like a stretched-out version of the economic restart.
The most effective way to contain inflation during the transition, in our view, is to ensure the transition is gradual and orderly, so that supply can keep pace with shifting demand across sectors and higher energy costs can be absorbed over time. A transition left too late may keep inflation down in the short term but risks a much greater overall impact later on.
Would no transition at all be a better strategy for containing inflation? Not in our view: while the transition – even an orderly one – is likely to bring higher inflation, we believe it will still deliver a better outcome in terms of both the level and volatility of inflation than a failure to act. No climate action would mean rising global temperatures, more frequent severe weather events and greater economic damage: in previous work, we estimated that no climate action would result in a cumulative loss in economic output of nearly 25% over the next 20 years. We would expect more frequent and sharp spikes in energy, food and other prices due to severe supply constraints – akin to a pandemic on repeat.
Labor shifts needed for transition
Net employment change, 2020 vs. 2052
Sources: BlackRock Investment Institute and IMF, September 2021. Notes: The chart shows the contribution of different sectors to the global change in employment between 2020 and 2052 as a result of the green transition, in IMF simulations using the G-cubed macroeconomic model; see the IMF World Economic Outlook 2020, chapter 3.
A world shaped by supply constraints will bring more macroeconomic volatility. There is no way around this because – unlike when inflation is driven by demand – policy cannot stabilize both inflation and growth at the same time: it has to choose between them. In other words, central banks have to either accept higher inflation or destroy demand to squeeze wages and prices to rein in inflation. Given the historical relationship between unemployment and inflation, if central banks had sought to keep inflation close to 2% amid the supply constraints experienced in the restart, this would likely have meant needing to drive the unemployment rate up to nearly double digits – see the chart.
Greater macro volatility – in both growth and inflation – implies greater market volatility and higher risk premiums on both bonds and equities. To minimize growth volatility, central banks will want to live with supply-driven inflation, provided inflation expectations do not become unanchored. This is one reason why the current policy response to higher inflation has been much more muted than in past episodes – a key theme in our 2022 Outlook. Recent research (Guerrieri et al, 2021)
says that central banks should accommodate inflation if caused by a need to reallocate across sectors. Doing so allows prices to rise in sectors benefiting from greater demand, relative to prices in sectors losing out. This helps economies to adjust and ultimately means supply constraints are less persistent.
We think central banks should live with current inflation pressures for now. They will likely take their foot off the gas this year by removing stimulus and returning rates toward more neutral settings – but this is a far cry from slamming on the policy brakes to deliberately destroy activity and bring inflation down. Notably, despite bringing forward materially the expected path of Fed rate hikes in recent weeks, markets are still pricing a muted overall hiking cycle.
Yet we expect negative bond returns this year. This has less to do with central bank policy than it does with the intrinsic features of this macro landscape. Faced with more inflation volatility, investors would question – as they have in recent weeks – the perceived safety of holding longer-term government bonds at historically low yield levels. Higher yields from a renewed term premium – which has largely been near or below zero in recent years – are not ultimately bad for stocks if they reflect a relative shift of investor preferences away from bonds and towards other assets. In fact, a muted central bank response to inflation means we expect inflation to persist without damage to growth, supporting risk assets in the longer term. This is why we are underweight government bonds on both a tactical and strategic horizon.
The primary risk we see is that central banks hit the brakes if constraints persist and they perceive that higher inflation could feed into inflation expectations. This would be bad for bonds and stocks as policy rates rise to restrictive levels and slow growth. Some of that risk may be priced in at points – like in recent weeks – as markets adapt to this new macro landscape. But if central banks do hit the brakes, they will likely learn that it comes at too great a cost and will be forced to reverse course. At the points this risk is priced, yield curves will tend to flatten or even invert.
High cost of pushing inflation down
U.S. unemployment rate and CPI inflation, 1995-2021
Source: BlackRock Investment Institute, U.S. Bureau of Labor Statistics, with data from Haver Analytics, January 2022. Notes: The chart shows the U.S. unemployment rate (horizontal axis) compared with the U.S. annual core inflation rate (measured by the year-on-year percentage change) for different periods (vertical axis). All data are at monthly frequency.
Read our past macro and market perspectives research >here.