Thriving in a new market regime

Learn more about our 2022 Outlook:

A new market regime

We see 2022 heralding a new regime by delivering global stock gains and bond losses for a second year – what would be a first since data started in 1977. This unusual outcome is the next phase of our new nominal theme that is still playing out: Central banks and bond yields have been slower to respond to higher inflation in the powerful restart than in the past. That should keep real, or inflation-adjusted, bond yields historically low and support stocks.

The big change in 2022: Central banks will be withdrawing some monetary support as the restart does not need stimulus. We see more moderate equities returns as a result. We expect the Fed to kick off rate hikes but remain more tolerant of inflation. The Fed has achieved its inflation target, so its interpretation of its employment mandate will determine the timing and pace of higher rates. The European Central Bank, facing a weaker inflation outlook, is likely to stay easier on policy.

We had flagged inflation - now we’re Living with inflation.

A restart like none other

We’ve never had an economic restart like this. Add repeated, outsized data surprises to the mix – both to the upside and the downside – and confusion is natural among policymakers and markets adapting to a new reality.

At the same time, central banks are implementing new frameworks that change how they react to inflation. The risks arising from new Covid-19 strains only add to the confusion. We cut through numerous possibilities to ask: What would it take for us not to be in this new market regime?

What could go wrong?

We see two ways our new market regime view could be wrong. First, central banks might react differently. They could – in the face of persistent inflation pressures, perhaps tied to new Covid-19 strains, revert to their old response to inflation.

Central banks could also be forced to be more aggressive if inflation expectations become de-anchored. We would be faced with inflation significantly above target, rising interest rates and falling growth: a classic stagflation scenario that is bad for both bonds and equities. Second, we could be wrong about growth prospects.

The chart shows how different our and the market’s view of future Fed rate hikes is from how the Fed might have reacted historically to the current mix of slack and inflation. In the past, we believe the Fed would have been pushing up rates in 2021 - again helping confirm this is a new regime.

It’s different this time
U.S. CPI inflation, federal funds rate and estimates, 1990-2025

Forward-looking estimates may not come to pass. Source: BlackRock Investment Institute, Federal Reserve Board, U.S. Bureau of Labor Statistics, Bloomberg, with data from Haver Analytics, December 2021. Notes: The chart shows the U.S. nominal federal funds rate (orange line), year on year headline CPI inflation (yellow) and some projected paths of the nominal federal funds rate. The U.S. CPI shown from 2022 - 2025 are our estimate embedded in our Capital Market Assumptions. The dotted red line shows our own projection of the federal funds rate. The purple line shows the path that would have been implied by a simple monetary policy rule linking the choice of policy rate to the rate of inflation and the level of the output gap. The pink line shows the current market-implied path.

Staying invested

How to thrive in this new market regime? We prefer equities in the inflationary backdrop of the strong restart. We favor DM stocks over as we dial down risk slightly amid rising risks to our base case.

We are underweight DM government bonds – we see yields gradually heading higher but staying historically low. We prefer inflation- linked bonds, partly as portfolio diversifiers. On a strategic horizon, we like private markets for their diversification and return potential.

Outlook in charts PDF

Staying pro-risk

The broadening economic restart, coupled with global central banks’ resolve to maintain easy financial conditions, keeps us pro-risk. We favor equities over credit and government bonds on both a strategic and tactical investment horizon.

Directional views

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

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, December 2021

Our base case: New nominal

We expect mildly higher inflation with a muted central bank response, keeping real rates historically low. Stocks can thrive, but bonds still suffer as the yield curve modestly steepens.

Other regimes explained

Safety premium questioned
The perceived safety of government bonds is questioned amid rising debt levels. Investors demand a larger compensation for the risk of holding long-term bonds. The yield curve steepens sharply. Yet this is a relative asset shift: equities can still do well.

Productivity boom
Sustained capital investment boosts potential growth, keeping the macro environment disinflationary. The Fed is patient and keeps policy loose, with rates below neutral. The yield curve steepens, real yields stay low, and risk assets do well.

Slamming the brakes
Delays to the restart, perhaps due to a new vaccine-resistant virus strain, result in weaker growth but persistently higher inflation. Central banks aggressively push against inflation, initially sparking a surge in yields. Result: recession with high inflation. The yield move hits stocks hard.

Runaway inflation
Inflation expectations become unanchored in the post-Covid confusion. A messy transition to net zero could exacerbate this. 1970s-style stagflation is back. Yields surge across the curve and risk assets sell off.

Stagnation
Growth slumps. Inflation pressures abate because labor market slack holds back wage growth. Central banks are unsuccessful in reviving growth and inflation. The yield curve flattens, and equities take a hit as earnings slump.

Classic risk-off
Asset bubbles form and burst. Trade wars flare up again and hurt global activity. Central banks struggle to respond. Long- term yields fall sharply from a flight to perceived safety and the term premium turns negative again. Risk assets suffer.