A surfer bracing for the impact from the incoming wave

Bracing for volatility

MAY UPDATE | Much has changed since our 2022 outlook - a war, an energy shock, the Federal Reserve’s pivot on monetary policy and a worsening macro outlook. We have reduced our portfolio risk-taking as a result and brace for market volatility ahead.

Investment themes


Living with inflation

Central banks are facing a growth-inflation trade-off. Hiking interest rates too much risks triggering a recession, while not tightening enough risks causing runaway inflation. The Fed has made it clear it is ready to dampen growth. Implication: We are neutral developed market (DM) equities after having further trimmed risk.


Cutting through confusion

The Russia-Ukraine conflict has aggravated inflation pressures. Trying to contain inflation will be costly to growth and jobs. We see a worsening macro outlook due to the Fed’s hawkish pivot, the commodities price shock and China’s growth slowdown. Implication: We stay underweight U.S. Treasuries and overweight inflation-linked bonds.


Navigating net zero

Climate risk is investment risk, and the narrowing window for governments to reach net-zero goals means that investors need to start adapting their portfolios today. The net-zero journey is not just a 2050 story; it's a now story. Implication: We favor equity sectors better positioned for the green transition.

Read details of our Q2 market update:

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A worsening market outlook

Both stocks and bonds are down year-to-date as policy confusion, the war in Ukraine, an energy shock and a worsening growth outlook in China roil markets. This is why we brace for more volatility in the short run.

We still see stocks up and bonds down for a second year in a row in the long term – that would be a first since data started in 1977.

Strategically underweight bonds

Bond returns have been historically poor because the Fed, along with other major central banks, has pivoted to normalize rates faster than expected. Rates are normalizing to pre-Covid levels as economies no longer need stimulus – this is a big change from central banks’ guidance at the end of last year. We remain underweight bonds as we see long-term yields climbing further. We believe investors will start questioning bonds’ perceived safety premium – and demand extra compensation for the risk of holding them in the inflationary environment.

Equities have also had negative returns (see the chart below) amid a worsening macro picture. We expect lower growth this year, especially in Europe, and higher and more persistent inflation.

Global equities vs. global bonds, annual returns, 1977-2022


This chart shows that both bonds and equities have seen negative returns so far this year.

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 Refinitiv Datastream and Bloomberg, May 2022. Notes: The chart shows annual returns for global equities and bonds in U.S. dollar terms from 1977-2021. Index proxies are the MSCI All-Country World index for equities (MSCI World before 1988) and Bloomberg Global Aggregate index for bonds (U.S. Aggregate before 1991).

A hawkish pivot

The Fed’s hawkish pivot this year has been stunning, and pronouncements on reining in inflation have become regular fare. Chair Jerome Powell in May 2022 said the Fed would keep hiking rates until inflation is “tamed” – a comment that dismisses any trade-off or the lagged effect of monetary policy on the economy.

The Fed now appears to be constraining itself to the hawkish side of policy options with such language, just as talking about the jump in inflation being “transitory” last year boxed it in when inflation proved more persistent and forced a sharp pivot. We think the Fed could be forced into another sharp pivot later this year, which we expect rather than a recession. These Fed pivots are driving market volatility, in our view.

Market expectations are now calling for the Fed funds rate to zoom up to a peak around 3% over the next year, more than doubling since the start of the year. For the European Central Bank, market pricing reflects four hikes this year and nearly 1.4% next year. That is well above our estimate of neutral for an economy at real risk of stagflation this year. The equity selloff this year makes sense from this perspective – if you believe that the market’s view of the Fed and ECB rate paths are right.

A complex reality

The growth reality will be more complex – both from the policy trade-off it faces amid a deteriorating macro backdrop, especially China’s slowdown, and Europe facing stagflation. That’s why we expect a dovish pivot later in the year.

We stick to our view of the Fed raising rates to around 2.5% by the end of this year – and then pausing to evaluate the effects. We still see the U.S. economy’s momentum as strong – we expect growth of around 2.5% this year, slightly below consensus and far from recession. Equities may have short-term, technical rebounds. Yet until the Fed starts to pivot, we don’t see a catalyst for a sustained rebound in risk assets.

Reducing portfolio risk-taking

We have further reduced portfolio risk after having trimmed it to a benchmark level with the downgrade of European equities. We are now neutral DM equities, including U.S. stocks. But a dovish pivot by the Fed would spur us to consider leaning back into equities.

Reducing portfolio risk-taking

We have cut our portfolio risk-taking in light of a worsening economic outlook: a war, an energy shock, central banks’ hawkish pivot and a growth slowdown in China.

Directional views

Strategic (long-term) and tactical (6-12 month) views on broad asset classes, June 2022

Note: Views are from a U.S. dollar perspective, June 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, June 2022

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.

Higher energy burdens

The hit to euro area growth, with its heavy reliance on Russian gas, could be large on top of higher inflation. The current energy burden in Europe is more than twice that of the U.S., risking stagflation.

 This chart shows that energy as a share of GDP has recently jumped in the European Union and the U.S. Europe’s energy burden is now around twice that of the U.S.

Sources: BlackRock Investment Institute and BP Statistical Review of World Energy 2021, with data from Haver Analytics, May 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 banks

Central banks face a tough growth-inflation trade-off. The Fed has projected a large and rapid increase in rates over the next two years, and raised rates by 0.5% in May - the largest increase since 2000. We see the Fed delivering on its projected rate path this year but then pausing to evaluate the effects on growth.

This chart shows that both markets and the Federal Reserve are projecting a rapid increase in the level of interest rates in the next two years.

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, May 2022. Notes: The left 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. 

China slowdown to ripple across globe

China’s slowdown is set to ripple across the globe. The hit to Chinese growth is starting to rival its 2020 shock and already surpasses the one from the global financial crisis. This will reduce growth in major economies and nudge up DM inflation at a very inopportune time when higher inflation is already proving more persistent.

This chart shows a rapid fall in China’s Purchasing Managers’ Index in the last few months, this indicates a slowdown in activity that we think will also reduce growth in other major economies.

​Sources: BlackRock Investment Institute, S&P Global and Caixin, with data from Refinitiv Datastream, May 2022. Notes: The chart shows composite (manufacturing and services) Purchasing Managers’ indexes (PMI). An index level above 50 indicates an improvement in economic activity, while an index level below 50 indicates a decline. S&P PMIs are used for U.S. and Euro area, Caixin for China.​

Meet the authors
Jean Boivin
Jean Boivin
Head of BlackRock Investment Institute
Wei Li
Global Chief Investment Strategist – BlackRock Investment Institute
Alex Brazier
Deputy Head of BlackRock Investment Institute
Vivek Paul
Senior Portfolio Strategist, BlackRock Investment Institute
Elga Bartsch
Elga Bartsch
Head of Macro Research
Scott Thiel
Scott Thiel
Chief Fixed Income Strategist

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