BLACKROCK INVESTMENT INSTITUTE

Portfolio construction

A new inflation playbook

One important consequence of the joint monetary and fiscal policy revolution for strategic investment decisions is the potential for a more muted response of nominal yields to higher inflation – a break from the past patterns. See our paper Preparing for a higher inflation regime of September 2020 for why we see higher medium-term inflation. We expect the disinflationary forces from the Covid-19 shock to dissipate and give way to structural inflationary forces, such as rising production costs globally and the impact of changing central bank policy frameworks. Central banks appear committed to limit any rises in nominal yields even as inflation picks up. Investors will need a new playbook to navigate this. Yet market pricing of inflation, based on breakeven inflation rates, suggest expectations of low inflation persisting are still widely held. The large gap between our expectation of inflation’s likely trajectory and that priced in by markets offers a strategic investment opportunity, in our view. We underweight government bonds and maintain a higher strategic allocation to equities than in typical periods of rising inflation.

Portfolio implications of the current vs. historical inflation playbook

Hypothetical strategic 10-year U.S. dollar allocation under different inflation scenarios, November 2020

Strategic asset preference

This information is not intended as a recommendation to invest in any particular asset class or strategy or as a promise - or even estimate - of future performance.

Sources: BlackRock Investment Institute, December 2020.  Data as of 30 June 2020. Notes: The chart shows hypothetical 10-year USD asset allocation to U.S. public assets under two scenarios: the historical playbook where higher inflation expectations feed into higher nominal yields and ourcurrent playbook embedded in our CMAs where higher inflation expectations feed through less to nominal yields and more to lower real yields than the past. We use the macro assumptions and return estimates described here to construct these hypothetical SAAs. For the left-most bar, there is no assumed rise in inflation expectations. The hypothetical portfolio may differ from those in other jurisdictions, is intended for information purposes only and does not constitute investment advice. This estimate is illustrative only and does not take into account other factors such as the precise impact of inflation on individual equity sectors. The estimated drag on returns at the top end of the range is equivalent to our assumptions of the alpha contribution to an SAA of a top-quartile U.S. fixed income manager as shown in our 2018 paper Blending alpha-seeking, factor and indexing strategies: a new framework.

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