What lies ahead for fiscal spending and monetary policy?

What lies ahead for fiscal spending and monetary policy?

Throughout the pandemic, fiscal stimulus and easy monetary policy provided a bridge to growth. Even though support at the current scale isn’t expected to continue as economic activity ramps up, the influence of pandemic era policies may continue to unfold in years to come. Explore BlackRock's insights on what it means across asset classes.

Key themes:

1. Policy normalization and living with inflation

Markets have started the new year on a jittery note, with worries centering on Fed rate increases and policy normalization. These moves are worth putting into context. Long-term rates remain at the low end of their historical ranges, with the real rate on the 10-year Treasury at roughly -0.75%. Second, although markets now expect rate increases to start sooner than they did a few months ago, the expected cumulative increase in rates over the next three years is essentially the same as it was before the Fed's hawkish pivot. Such an increase would represent the most muted inflation response in decades.

We see quantitative tightening (QT) – the shrinking of the Fed’s balance sheet - working mostly through the term premium, the extra compensation investors demand for the risk of holding government bonds. The 2018-19 experience suggests a small impact from QT alone. Yet in the context of rising inflation, QT could add to a broader narrative around the need for greater compensation from fixed income relative to risk assets. 

This new regime implies a more fundamental asset reallocation. The Fed might be contributing to this reallocation rather than causing it. The focus for monetary policy in 2022 is not on hitting the brakes but on taking the foot off the gas and returning to a more neutral policy stance.

2. Cutting through confusion

There are no historical parallels to today’s confluence of events – the economic restart, the appearance of new virus strains, supply-driven inflation and the development of new central bank frameworks. As a result, the current environment is marked by confusion. Cutting through this confusion is key. To do so, it is essential to identify risks in the new regime. We see three main risks.

The first risk is that a global resurgence in COVID-19 infections could delay the restart of economic activity. This problem could be particularly acute in China if its zero-COVID approach results in repeated shutdowns. The Omicron strain appears less severe than other variants in populations with high vaccination and immunity rates. Moreover, evidence from almost two years of the pandemic shows that successive waves of the virus have had less and less impact on GDP – a positive for the growth outlook. We expect new virus strains to delay, but not derail, the restart.

The second risk is that central banks could revert to previous policy responses in the face of persistent inflation pressures.

Finally, inflation expectations could diverge significantly from policy targets in the post-COVID confusion, forcing central banks to react aggressively. This development could lead to stagflation — high inflation becoming persistent amid stagnating activity.

3. Navigating net zero

Climate change and the race for the world to reach net-zero emissions by 2050 also play into the general confusion. There is a popular notion that tackling climate change may lead to higher economic costs and inflation. We don’t agree. Yes, the outlook would be better if climate change didn’t exist. But that’s not an option; climate change is real. A smooth net-zero transition, therefore, has to imply higher growth and lower inflation than any alternative, in our view. No climate action or a disorderly transition suggests lower growth and higher inflation. The energy crunch in late 2021 revealed that the transition so far has been lopsided: Reduced investment in fossil fuels has not been offset by a boost to investment in alternative energy and its infrastructure. A smoother and more balanced transition will not only need clean energy but also new technologies to store and distribute it.

In our view, demand for fixed income will continue to exceed expectations. One reason: Corporate pension funds, at their highest average funding status in almost two decades, are likely to reallocate out of risky assets and into risk-free securities.

We expect strong demand to hold yields in check, albeit at higher levels than in recent years amid historically high inflation. When the dust settles, we expect real rates to remain historically low. Risk spreads also should stay contained as strong nominal growth keeps fear of corporate defaults at bay.

We think yields in the Bloomberg-Barclays U.S. Aggregate Index, a hybrid of risk-free and risky assets, should rise in 2022. But if both risk-free yields and risky spreads stay relatively contained, as we expect, this broad index looks unlikely to deal investors crippling losses. Moreover, we’re optimistic about astute active investors’ ability to generate a positive return in fixed income.

U.S. fiscal spending and central bank policy outlook

Although new fiscal policy support may no longer be likely, in our view the risk of fiscal tightening in the next three years is near zero. The policy burden will be on the Federal Reserve. The Fed is likely to normalize monetary policy in 2022 only in the event of a second consecutive year of impressive nominal GDP growth (see table below).

For investors, how much of that growth comes from price increases versus real growth will be critical. In our view, one of the greatest challenges this year will be navigating changes to portfolio allocations as the Fed evolves its policy stance.

Expectations for nominal growth in 2022 are historically high

Nominal growth expectations in 2022

Source: Blooomberg, data as of December 8, 2021.

Although new fiscal policy support may no longer be likely, in our view the risk of fiscal tightening in the next three years is near zero. The policy burden will be on the Federal Reserve. The Fed has begun to normalize monetary policy in the context of a second consecutive year of impressive nominal GDP growth (see table below). For investors, how much of that growth comes from price increases versus real growth will be critical. In our view, one of the greatest challenges this year will be navigating changes to portfolio allocations as the Fed evolves its policy stance.

We think we have officially begun a two-stage process of gradual departure from emergency monetary policy conditions. The first stage being a return to a more neutral, normal monetary policy and then, secondly, a potentially more restrictive policy to address what has clearly been surprisingly high and sticky levels of inflation. First, in getting to neutral we think that over the next year and a half the Fed will bring policy rates to just below the level of potential growth (between 1.5% and 2% Fed Funds) and will allow for the run-off of the extremely large “excess-excess reserves” sitting in the banking system. It is clear at this point that the Fed has inflation firmly in its sights, despite the still maturing nature of this economic recovery, but it has also very much kept the door open to adjust policy if the economy slows from here.

The velocity of money is set to bounce from historic, pandemic-induced lows

The modern history of US M2 Velocity

Modern history of US M2 velocity

Source: Bloomberg, data as of September 30, 2021.

The real economy has momentum. We think M2 velocity will bounce sharply from its lowest level in history (see graph above), buoyed by strong sentiment in both the real and financial economies, and we think credit creation could drive growth after QE ends in 2022.

Accelerants of growth: technology and the net-zero economy

Parts of the tech sector are set to grow exponentially over the next decade. Early investors in virtual reality, augmented reality, and similar areas are likely to be rewarded. Medical investment is set to soar, and energy infrastructure will be an important secular theme for the net-zero transition.

Portfolio implications

We think investors need to be able to engage market segments beyond those in the Aggregate index, including those below investment grade. We now see value in the short-to-belly segment of the U.S. Treasury market, where yields offer some downside protection for the first time since the onset of COVID. Bank loans also may perform well with a strong economy and modestly higher rates. Bespoke securitized assets in commercial real estate, consumer credit and CLOs should round out investors’ fixed income portfolios.

The era in which policy floated all boats is ending. Sector selection will be key, as will deciphering dispersion within each sector.

The paths of inflation and interest rates, megatrends such as digitization and decarbonization, and numerous sub-themes all look to have a profound effect on alternatives and private markets in 2022. Regional growth and inflation data are likely to result in diverging monetary policies: tightening in the U.S., the European Central Bank likely staying on hold, and the People’s Bank of China easing due to slower growth. Risk of policy error has risen, in our view, which may impact credit conditions across regions. Meanwhile, U.S. fiscal spending plans could have an outsized impact in sectors like infrastructure and healthcare, which are political priorities. That said, we are likely to see less cooperation across the political aisle as the U.S. approaches a contentious midterm election.

Real assets

This year is set for a broader, stronger upswing in real assets, marked by a fast rebound upon reopening and a slow rebuild to recover lost capacity. We see the cyclical rebound, technological changes and the response to climate change as three dominant drivers of the real assets outlook.

At the same time, we expect the market rebound to play out differently in economies around the world, due to variations in reopening strategies, a longer-term push toward re-shored supply chains, differences across sectors, and investment shifts from other asset classes to achieve higher and more resilient yields.


The recently passed Infrastructure Investment Jobs Act (the Act) should result in greater infrastructure investment from private capital in the U.S. We believe many of the projects included in the Act should lead to stronger economic growth and open the door for greater private investment in certain infrastructure sectors. These projects range from cyber security measures to electric grid modernization and carbon capture.

The Act totals USD $1 tr over the next decade, including USD $550 bn of new spending on top of USD $450 bn that renews existing transportation funding. The funds will be distributed through grants and loans from federal agencies including the Department of Transportation and Department of Energy, tax credits and other financial incentives. The Act unlocks surface transportation for new concessions that allow private investors to come in as operators. It also encourages the use of public-private partnerships (PPP), which could lead to even more assets coming to market.

Components of new spending from the Infrastructure Investment and Jobs Act of 2021 (category, $ billion USD spending)

Spending components, 2021 IIJA

Source: Senate Committee on Environment and Public Works (EPW), Infrastructure Investment Jobs Act. August, 2021.

The Act also should lead to more private activity bond issuance collateralized by infrastructure assets. This process will be accomplished by allowing qualified broadband and carbon capture to become eligible for tax-exempt status, and by doubling the cap on highway tax-exempt bonds from USD $15 bn to USD $30 bn. New funding for projects elsewhere in the Act could lead to additional taxable supply. Additionally, new equity investments by private investors will create further need for infrastructure debt during the coming decade.

U.S. Infrastructure debt issuance in 2015 vs. 2020

Infrastructure debt issuance

Source: Inframation, infrastructure debt issuance in U.S. in 2015 and 2020

The massive and long-running move from fossil fuels to renewables is broadening beyond wind and solar power generation, as more power segments — particularly blue and green hydrogen, carbon capture, electric vehicle charging and battery storage – take advantage of falling costs, rising scale economies and improving commercial viability. The ability to reduce the carbon footprint of cars, power plants and factories presents new commercial opportunities to achieve net zero, alongside the big and essential buildout in renewable power. For example, carbon capture could become a massive opportunity for infrastructure investors, but the technology needs improvement to be economical.

Carbon sequestration is essential in the road to net zero by 2050

Carbon emissions by source projection

Source: Goldman Sachs Global Investment Research; as of June 23, 2021.

Hydrogen fuel is another example of an infrastructure technology that could be in high demand in the future with adequate funding from the Act. Utilities are quickly moving generation to renewable sources, but the two most prominent types of clean energy, solar and wind, are intermittent, and peak generation does not always match peak demand. Natural gas "peaker" generators, which utilities use during peak demand times, are one way to fill in the gap, and grid-level batteries can help, but both solutions have limitations. Utilities believe that hydrogen could be the key to mass deployment of renewable energy on the grid scale, but its efficiency needs to improve.1 Private companies are investing in hydrogen as a fuel, but government support can hasten the move from the fringe to a more serious component of the U.S. energy stack.

2021 was remarkable in many respects. Value rivaled growth for the first time in half a decade, earnings growth and positive earnings surprises were historically high, and inflation readings exceeded any seen by many present-day investors. What next?

We see growth and value running neck and neck in 2022, offering opportunity for both investment styles. Earnings should remain strong as companies look to meet pent-up demand for products and services. Earnings surprises, on the other hand, are already moderating toward the long-run trend (see chart below). Conversely, inflation may continue to overdeliver. While inflation is a concern and a source of volatility, it also makes stocks the most compelling choice among the major asset classes. Individual companies will manage through a high-inflation environment in different ways, highlighting the importance of a stock-by-stock approach.

2022 earning outlook: Less surprising, more normalizing

S&P 500 earning per share (EPS) surprise, 2003-2021

2022 earnings outlook

Source: BlackRock Fundamental Equities, with data from FactSet as of Nov. 10, 2021. The chart shows the average EPS surprise of companies in the S&P 500 Index, relative to consensus analyst expectations, for each quarter since 2003. It is not possible to invest directly in an index.

Inflation impediments

Inflation is our top concern. Companies have been more than able to pass on rising costs to this point, but we’re watching inflation’s potential to squeeze profit margins, particularly if consumers become less willing to pay up for goods and services. Inflation’s impact on monetary policy is an even bigger consideration. The greatest threat to stocks’ risk-reward prospects is the possibility that nominal rates rise to the point where real interest rates are no longer negative.

Despite these concerns, stocks are one of the best places to be in a world with rising inflation. Our review of data back to the 1920s finds that equities have performed well during inflationary environments when inflation wasn’t out of control (over 10%). Value stocks have performed particularly well in moderate inflation environments (5%-10%).

Fiscal and monetary policy support

Swift, significant and globally coordinated fiscal and monetary policy stimulus arrived early in the COVID-19 crisis and has continued throughout it, propping up economies and staving off financial crisis. Central banks are now making strategic moves away from emergency measures. In the U.S., the Fed has started to taper its monthly asset purchases, while contemplating interest rate hikes but not immediately enacting them. We acknowledge the strong risk that inflation may force the Fed to act sooner rather than later. Yet it is important to note that rates would be rising from a historically low base, and real rates are likely to remain negative. This backdrop would remain supportive for stocks.

Cash comes in from the sidelines

Both businesses and individuals held cash aside amid the height of the pandemic uncertainty. As confidence returned in 2021, companies deployed excess cash, with half of dividend payers in the Russell 1000 Index raising or initiating a dividend. We see even better prospects for capital returns through share buybacks and growing dividends in 2022.

Household balance sheets are in good shape, unemployment is down, and wages are up. Excess cash has been finding its way into equity markets, with equity ETFs and mutual funds attracting more in 2021 than in the past 19 years combined, according to analysis from BofA Global Research and EPFR data. Although the bulk this trend may have occurred, we see room for more. 

The pandemic led to historic levels of fiscal stimulus being pumped into the economy. Efforts including unemployment benefits, business loans and stimulus checks helped strengthen balance sheets across the country and avoid the prolonged effects of a financial crisis. Meanwhile, inflationary pressures have been building both within the U.S. and outside. Prices of commodities like oil and gasoline have climbed due to supply-chain issues and an ongoing clean-energy transition.

Such changes have prompted investors to seek inflation protection in areas like commodities and real estate investment trusts (REITS). The most prominent impact on financial markets has been negative real rates in fixed-income investments. Institutional investors, trying to make up for those lost returns, have turned to alternative markets like private equity, private credit and real estate.

Fiscal spend and inflation protection

Our bird’s-eye view is that fiscal spending will continue to be good for growth but that repercussions tied to inflation will be with us for some time.

To track the impact of the Omicron variant on shipping and other economic activity, we are monitoring indicators such as container shipping. Goods prices have been an important source of inflation over the course of the pandemic – a key difference from the previous decade. As Omicron cases peak, consumption could rotate away from goods and towards services. If this shift is sustained, there is room for goods demand to decline relative to services.

U.S. Core Goods CPI vs. Core Services CPI: 2010-2020

Core Goods CPI vs Core Services CPI

Source: Bureau of Labor Statistics; as of January 2022.

Commodities can provide inflation protection, with our research showing that energy markets have the strongest inflation-protection benefits, while industrial metals give moderate protection, and agriculture and livestock give very minimal protection. We’ve also found that real estate investment trusts, which are thought to provide an inflation hedge, don’t consistently provide protection during periods of rapid price increases.

In the current market environment with accelerating inflation, investors have been sobered by the full valuations in equities and fixed income, and market volatility that has been creeping higher. Furthermore, investors are increasingly questioning the assumption that stock and bond markets are negatively correlated, weakening the diversifying properties of fixed income investments. Hence, there are more investors seeking out alternatives to tap into a broader series of returns with lower balance sheet volatility.

The role of alternatives in 2022

Different institutions can have varying priorities, ranging from inflation hedging to liquidity requirements. However, these goals have often conflicted with the negative interest-rate environment in the public markets. That’s increased the need by institutions to deepen their commitments to alternative investments, such as private credit and real estate.

Private credit and diversifying hedge-fund strategies can serve as replacements for fixed-income in diversified portfolios. These exposures hold the potential to deliver annual returns in the high single digits to low double digits, with benefits for a portfolio’s diversification. We believe investors should weigh concerns about illiquidity against the potential for poor performance in core fixed income.

In some cases, private equity and real assets such as real estate and infrastructure can help reduce reliance on public investments. Within real assets, we’ve found that investors—depending on their needs and risk profile--can find steady cash-flow-generating assets, such as apartment buildings, or delve into special-situation and relative value investments, like distressed commercial properties.

Real estate and infrastructure also present opportunities for investing with an ESG lens. For instance, some institutions have been investing in infrastructure opportunities like solar plants, wind farms and clean-energy facilities. In these volatile and inflationary times, what’s been key is to find brick-and-mortar assets to add diversification, while also aligning with the longer-term goals of institutions if they have broader aims in ESG.

Wei Li
Managing Director, Global Chief Investment Strategist at the BlackRock Investment Institute
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Tony DeSpirito
Managing Director, Director of Investments, U.S. Fundamental Equities and Head of U.S. Income & Value Team
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Rick Rieder
Managing Director, Chief Investment Officer, Global Fixed Income
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Jeffrey Saef
Managing Director, Head of Americas for Multi-Asset Strategies & Solutions
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