QUESTION OF THE WEEK - SPECIAL EDITION

What key debates shape the 2021 Global Outlook?

In this special edition, we explore three debates from the BlackRock Investment Institute’s 2021 Outlook Forum. The event convened some 100 BlackRock investment experts and anchored our 2021 investment views.

    Inflation

    A market debate is simmering about inflation. Many still see deflationary forces in the near term – and inflation only in the longer term. But timing is everything. What do you see as the most likely horizon for sustained inflation – core inflation above 3% – to hit markets? See below for the results of our public poll.

       49%

    1. Higher inflation is just around the corner. The policy revolution, a virus-led recovery and a revival of animal spirits will combine to push inflation above target within two to three years.

      38%

    2. We won’t see sustained higher inflation until the next decade. Factors that could help push it higher, such as population aging and a rewiring of globalization, are very slow moving.

      13%

    3. We won’t see 3%+ inflation over the course of most of our careers. The rewiring of globalization will be milder than many are expecting.

    Source: Blackrock Investment Institute with data from SurveyMonkey. Note: Data does not include results from BlackRock social media polls.

    Forty-nine percent of the responses to our public poll agree that higher inflation is just around the corner. Another thirty-eight percent of voters do not see sustained higher inflation until the next decade and thirteen percent do not see it at all during the course of their careers.

    On the other hand, the majority of BlackRock portfolio managers don’t see sustained higher inflation over the long-term. In the second most popular camp are those who believe that the policy revolution combined with surging animal spirits could finally spur inflation as the economy reopens following the Covid-19 shock. The BlackRock Investment Institute explores the question on rising inflation expectations by considering three driving forces.

    Rising inflation: 3 forces at play

    Poll results: What do you see as the most likely horizon for sustained inflation – core inflation above 3% – to hit markets?

    Forward-looking estimates may not come to pass. Sources: BlackRock Investment Institute and the Federal Reserve with data from Refinitiv Datastream, November 2020. Notes: The chart shows market pricing of expected average inflation over the coming five-year period. We show it using the five-year/five-year inflation swap which is a measure of market expectation of inflation over five years, starting in five years' time. In the chart, the lines are shifted forward five years. The orange and green dots show our current estimate of average U.S. CPI and euro area inflation for the same five-year period of 2025-2030. Euro area refers to all 19 member states.

    Rising production costs

    Production costs could rise on the rewiring of global supply chains and rising bargaining power of domestic workers as industries are re- or nearshored.

    New frameworks

    Central banks are fundamentally changing their policy frameworks with the intent of running inflation above targets.

    Political pressures

    The monetary-fiscal policy revolution - a necessary response to the Covid-19 shock - puts greater political constraints on the ability of central banks to lean against inflation.

    The “new nominal” is not simply about our expectation for a higher inflation regime in the next five years. It means stronger growth in the near term, and eventually higher inflation - without the typical rise in nominal bond yields. As a result, we see very different market implications than in the past.

    Central banks have signaled they will be more willing to let economies run hot with above-target inflation by changing their policy frameworks to make up for prior inflation undershoots. At the same time, the fiscal monetary policy revolution – a necessary response to the Covid-19 shock – risks greater political constraints on central banks’ ability to lean against inflation. We see central banks likely curbing nominal yield rises to prevent an unwanted tightening of financial conditions.

    We see other reasons for higher inflation, as detailed in Preparing for a higher inflation regime. Production costs are set to rise on the rewiring of global supply chains, while we see scope for corporates to exert their pricing power to protect profit margins. Corporate cost cutting may mitigate inflationary pressures in the near term. But even the moderately higher inflation in our base case – around 2.5-3% annually – would surprise markets after a decade of undershoots. See the Underappreciated inflation risks chart.

    Quotation start

    We can't expect nominal government bonds to provide as much ballast as they have in the past with yields so low.

    Quotation end
    Vivek Paul Senior Portfolio Strategist, BlackRock Investment Institute

    Developed market government bonds in portfolios are challenged; with yields near effective lower bounds and central banks limiting yield rises even as growth picks up, we believe they will be less effective as portfolio diversifiers. Real yields look to be headed lower – one reason why we favor inflation-linked securities on a strategic basis.

    Importantly, we believe this new nominal of constrained nominal bond yields will support risk assets. As a result, we are tactically more pro-risk and maintain a higher strategic allocation to equities than if higher inflation were to have its typical impact on nominal yields.

    Our commitment to sustainability

    We have reached an inflection point in sustainability. The European Union and China recently released more ambitious targets for reaching net-zero emissions. This will require major investment to make the green transition happen.

    Image of sheep changing direction in an open green field

    Seeing green

    Estimated carbon efficiency for MSCI sectors, December 2020

    Indexes are unmanaged and do not account f or fees. It is not possible to invest directly in an index. Sources: BlackRock Investment Institute with data from Refinitiv Datastream and MSCI, November 2020. Notes: The chart shows the carbon efficiency – measured as total carbon emissions relative to the aggregate firm value – for the sectors of the MSCI USA index. The carbon efficiency measure is shown in Z-score terms. Both Scope 1 (direct emissions from owned or controlled sources) and Scope 2 (indirect emissions from electricity purchased) are considered. These can help gauge the exposure of companies to carbon pricing initiatives as part of climate change mitigation policies. 

    Sustainability has become a key component of how we think about investing – and we are incorporating it into our return expectations across asset classes.

    The tectonic shift toward sustainability is reflected in shifting preferences and flows into sustainable assets. Our view is that this trend will play out over decades.

    We see carbon efficiency – or the volume of carbon emitted relative to a company's market value – as a key differentiator that will drive a repricing across sectors and companies. See the chart.

    Many argue that a costly green transition will weigh on growth, yet we believe this framing is misguided. The reason: We expect extreme weather and other effects of climate change to reduce potential growth in future decades. Efforts to mitigate the damage from climate change should boost economic growth relative to this new baseline.

    Quotation start

    This shock is a dress-rehearsal for disasters like those seen with climate change. Politics may listen more to science.

    Quotation end
    Carole Crozat Head of Thematic Research – BlackRock Sustainable Investing

    High emitters may face regulatory penalties, higher taxes and financing costs. Companies that use carbon most efficiently will likely have greater resilience against risks such as carbon taxes and enjoy richer valuations as investor preferences shift toward sustainable assets.

    Does sustainable investing mean giving up returns? This may become true eventually once “green” assets trade at a premium and “brown” ones at a discount. But we see a long transition period over which green assets can potentially outperform.

    Geopolitics

    U.S. President-elect Joe Biden faces an ongoing pandemic, a weakened economy and a deeply polarized country. A Democratic Senate is not our base case: Democrats need to win two Georgia seats in a January 5 runoff election – and as of early December polls suggested both races are tossups.

    Policy under a divided government – if Republicans retain control of the Senate– would have to reflect compromise rather than sweeping change, in our view. Big-ticket legislation – including large-scale fiscal stimulus and public investment, would face hurdles. Yet there may be some room for bipartisan compromise on issues such as R&D spending to meet the technology challenge from China.

    A less tense world

    BlackRock Geopolitical Risk Indicator, 2008-2020

    Source: BlackRock Investment Institute, with data from Refinitiv. Data as of Nov. 13, 2020, Notes: We identify specific words related to geopolitical risk in general and to our top risks. We then use text analysis to calculate the frequency of their appearance in the Refinitiv Broker Report and Dow Jones Global Newswire databases. We then adjust for whether the language reflects positive or negative sentiment, and assign a score. A zero score represents the average BGRI level over its history. A score of one means the BGRI level is one standard deviation above the five-year average. We weigh recent readings more heavily in calculating the average.

    The chief geopolitical implication is a more predictable U.S. approach to trade, foreign affairs, and working with allies.

    Tensions with Europe, particularly over trade, will likely ease. Reduced trade tensions and U.S. support for multilateral debt relief efforts should help EMs.

    Market attention to geopolitical risk has eased from 2018 peaks, as the BlackRock Geopolitical Risk Indicator chart shows.

    Quotation start

    We see a more traditional U.S. leadership approach, reflecting a focus on allies and a return to multilateral.

    Quotation end
    Tom Donilon Chairman – BlackRock Investment Institute

    Climate looks set to play a central role in U.S. foreign policy, as flagged by the naming of former Secretary of State John Kerry as U.S. climate envoy, and a planned rejoining of the Paris Agreement on climate change.

    We expect to see U.S. support for continued peacebuilding between Israel and Arab nations. The Biden administration looks set to launch a diplomatic effort to rejoin the Iranian nuclear deal, although a recent rise in tensions may complicate this. U.S.-China relations will continue to be marked by intense rivalry, particularly in the tech sector, in our view. Frictions may extend to the financial arena and human rights, even as we see room for the countries to cooperate on climate and public health policies.

    Curious to read more, take a look at our full 2021 Global Outlook report.

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