GLOBAL WEEKLY COMMENTARY

Debt ceiling showdown redux

Key points

Our pro-risk stance
We remain pro-risk and opt to look through any short-lived volatility that could result from a battle over lifting the U.S. debt limit and funding the government.
Market backdrop
U.S. consumer price increases slowed in August, but inflation pressure has broadened to core items less affected by the pandemic.
Week ahead
Several central bank policy meetings are in focus. We don’t expect growing inflation pressure to lead to an earlier rate liftoff by the Federal Reserve.

The U.S. needs to soon raise a self-imposed federal debt limit, or the “debt ceiling”, to avoid a debt default. We don’t see fundamental risks from the debt ceiling showdown – with a low risk of technical default and limited chance of a temporary government shutdown. Yet the twists and turns could trigger jitters in markets that have had an extended run higher. Still, we favor looking through any volatility and stay pro-risk over the next six to 12 months

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Calm before the storm?

Changes in 4-week Treasury Bill yields during debt ceiling episodes

The chart shows changes in the four-week Treasury Bill yields around past and current debt ceiling episodes. So far there have only been modest movements, in line with past episodes with the exception of 2017.


Sources: BlackRock Investment Institute, with data from Refinitiv Datastream, September 2021. Notes: The chart shows changes in yields of 4-week Treasury Bill (T-Bill) yields from 28 days before the debt ceiling “deadlines”, or the dates when the federal government exhausts its borrowing in selected debt ceiling episodes. These deadlines are August 2, 2011, Oct. 17, 2013, Sept. 29, 2017. We use Oct. 15 as the projected debt ceiling “deadline” for this year.

The Congress has acted to adjust the debt ceiling 78 times since 1960, according the Treasury Department. Over recent decades the debt ceiling has become a subject of intense partisan wrangling. A two-year debt ceiling suspension expired in July, and the Treasury Department said its “extraordinary measures”, or maneuvers to manage cash and debt in order to avoid breaching the debt limit, could run out next month if Congress doesn’t act. So far we have only seen modest movements at the front end of the Treasury yield curve – in line with market reaction ahead of recent debt ceiling deadlines with the exception of 2017. See the chart above. We see today’s unique market dynamics as contributing to the muted signal from the Treasury market. The Federal Reserve’s near-zero policy rate has intensified the hunt for yield, just as the central bank has become a large buyer of Treasuries. In addition, banking regulations since 2008 have helped broaden the buyer base for Treasuries.

Today’s macro environment is very different from previous debt ceiling episodes over the past decade.  An economic restart is underway in the U.S., and inflation pressure has increased amid pandemic-related supply disruptions. We uphold our tactical pro-risk stance as the restart broadens out, and what we call the new nominal – a more muted reaction from central banks to higher inflation than in the past – is also supportive of risk assets. This is in contrast with the debt ceiling showdown in 2011 that triggered a downgrade in the United States’ AAA sovereign credit rating by S&P just as the euro area debt crisis and worries about slower growth kept investors on their toes. It also differs from 2018, when worries about U.S.-China trade tensions and their impact on the economy were flaring up.

How will the debt ceiling showdown affect the prospects of Congressional spending plans? We believe it will unlikely derail the $1 trillion bipartisan infrastructure bill or the Democrats’ proposed $3.5 trillion spending plan on social policy and climate change - key legislative priorities ahead of the 2022 midterm elections. Yet we do expect the $3.5 trillion price tag on the Democratic-sponsored reconciliation package to be scaled down to help ensure the support of party moderates, who have balked at some of the proposed tax increases for corporates and high-earning individuals to offset spending.

We believe Congress will ultimately reach an agreement to raise or extend the debt limit, but likely not until right before the Treasury exhausts its borrowing capacity. That may come in late October or early November, but the timing is hard to estimate due to lumpy Treasury cash flows for Covid relief payments. The good news: Neither political party wants to see a technical default, and there are no calls for substantive spending cuts. Hence we do not believe the debt ceiling represents a fundamental risk to the market. The risk: The timeline to resolve the debt ceiling is tight. Political brinksmanship appears likely, and any miscalculation could lead to a short-lived government shutdown that triggers market volatility.

Bottom line: We expect Congress to ultimately reach an agreement on the debt ceiling, and see the odds of the federal government committing technical default –or violating terms of its debt - as low. Risk assets could suffer temporary pullbacks after an extended run higher, but we favor looking through any volatility and staying pro risk over the next six to 12 months. We recently downgraded U.S. equities to neutral on a tactical basis to fund an upgrade to European equities, as we see the baton of global restart being passed on to Europe from the U.S.; we remain underweight U.S. government bonds.

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U.S. inflation set to stay firm
What does the August consumer price index data tell us? Read more in our Macro insights.
BlackRock Investment Institute Macro insights

Assets in review

Selected asset performance, 2021 year-to-date and range

 The chart shows that Brent crude oil is the best performing asset so far this year among a selected group of assets, while spot gold 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 Sept. 16, 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 U.S. dollars, and the rest in local currencies. Indexes or prices used are, in descending order: spot Brent crude, MSCI USA Index, MSCI Europe Index, ICE U.S. Dollar Index (DXY), Bank of America Merrill Lynch Global High Yield Index, MSCI Emerging Markets Index, 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 U.S. 10-year benchmark government bond index, Refinitiv Datastream Germany 10-year benchmark government bond index and spot gold.

Market backdrop

The U.S. consumer price index (CPI) showed a slower pace of price increases in August, thanks to a moderate rise in core components and falling prices in Covid-related items such as airfares and car rentals. Yet price pressures appeared to grow in some non-Covid items, suggesting a broadening and more persistent inflationary pressure.

Week ahead

Sept 20  –Canada federal election
Sept 21-22 Fed, Bank of Japan policy meetings
Sept 23 –Euro area flash consumer confidence indicator; Bank of England policy decision; flash composite purchasing managers’ index (PMI) for the euro area, U.S. and UK.

Central banks return to the limelight this week amid rising and more persistent inflationary pressure. Yet we do not expect the growing price pressure to lead to an earlier policy rate liftoff from the Fed. PMI data from key developed economies could shed light on the impact of the delta variant surge on activity restart.

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Directional views

Strategic (long-term) and tactical (6-12 month) views on broad asset classes, August 2021

Note: Views are from a U.S. dollar perspective, August 2021. 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, August 2021

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.

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Read our past weekly commentaries here.

 

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

The new normal

 

The powerful economic restart is broadening, with Europe and other major economies catching up with the U.S. We expect a higher inflation regime in the medium term – with a more muted monetary response than in the past.

    • The new nominal has largely unfolded in 2021: the rise in long-term yields has been mainly driven by higher market pricing of inflation, with real yields remaining pinned well in negative territory.
    • We expect the Fed to start normalizing policy rates in 2023, a much slower pace than market pricing for lift-off in 2022 indicates. Fed Chair Jerome Powell reassured markets at the recent Jackson Hole symposium, making no announcement on tapering but giving a strong signal that one will come before year-end if employment gains keep up. He also made clear that tapering “will not carry a direct signal” with respect to a lift-off in policy rates.
    • The ECB tweaked its forward guidance after having recently set its inflation target at 2% in the medium term but rejecting an average inflation targeting framework. The central bank said it would keep policy rates on hold until it had seen “inflation reaching 2% well ahead of the end of the projection horizon and durably for the rest of the projection horizon.”
    • Tactical implication: We go overweight European equities and inflation-linked bonds. We cut U.S. equities to neutral.
    • Strategic implication: We remain underweight DM government bonds and prefer equities over credit.
Globalization

 

China is already a distinct pole of global growth. We believe it is time to also treat it as an investment destination separate from EM and DM.

    • Chinese authorities have started loosening policies as growth slows, yet we believe they will maintain the broadly hawkish policy stance over the medium term to stay focused on the quality of the growth.
    • We believe the clampdown on some private industries could go on for years, but its intensity would likely fluctuate. We have yet to see the peak of the regulatory campaign, but could see its pace and intensity to moderate amid slower growth.
    • We believe investors should be mindful of ongoing geopolitical tensions, which was underscored by the uncertainty around China’s clampdown on certain industries.
    • Tactical implication: We break out China from EM with a neutral stance on equities and an overweight to debt.
    • Strategic implication: Our neutral allocation to Chinese assets is multiples larger than typical benchmark weights.
Turbocharged transformations

 

There is no roadmap for getting to net zero, and we believe markets underappreciate the profound changes coming. The path is unlikely to be a smooth one – and we see this creating opportunities across investment horizons.

    • Certain commodities, such as copper and lithium, will likely see increased demand from the drive to net zero. Yet we think it’s important to distinguish between near-term price drivers of prices of some commodities – notably the economic restart – and the long-term transition that will matter to prices.
    • Climate risk is investment risk, and we also see it as a historic investment opportunity. Our long-run return assumptions now reflect the impact of climate change and use sectors as the relevant unit of investment analysis.
    • Tactical implication: We are overweight the tech sector as we believe it is better positioned for the green transition.
    • Strategic implication: We like DM equities and the tech sector as a way to play the climate transition.

Download the full commentary

Read our past weekly commentaries here.

Jean Boivin
Jean Boivin
Head of BlackRock Investment Institute
Jean Boivin, PhD, Managing Director, is the Head of the BlackRock Investment Institute (BII). The institute leverages BlackRock’s expertise and produces proprietary ...
Wei Li
Wei Li
Global Chief Investment Strategist - BlackRock Investment Institute
Wei Li, Managing Director, is Global Chief Investment Strategist at the BlackRock Investment Institute (BII), where she leads its team of investment strategists
Kurt Reiman
Kurt Reiman
Senior Strategist for North America, BlackRock
Kurt Reiman, Managing Director, is a member of the BlackRock Investment Institute (BII) and Senior Strategist for North America. In this role, Kurt contributes to the ...
Nicholas Fawcett
Member of the Economic and Markets Research Team– BlackRock Investment Institute
Nicholas Fawcett, Vice President, is a member of the Economic and Markets Research group at the BlackRock Investment Institute.

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