Market insights

Weekly market commentary

2022-11-28
  • BlackRock Investment Institute

Aging raises cost of curbing inflation

Market take

Weekly video_20221128

Nicholas Fawcett

Opening frame: What’s driving markets? Market take

Camera frame

We see an aging U.S. population as a key constraint on its workforce now and in the future. That means lower production capacity.

And that means lower growth or persistent inflation over time.

1: Workforce participation problem

The share of people participating in the workforce plummeted in the pandemic.

It has partly recovered, but we don’t see it doing so further because aging accounts for most of the decline since Covid, we find.

A bigger share of the population has reached retirement age and some workers retired early due to the pandemic.

2: Central banks face sharp trade-off

That means lower production capacity today.

Making for a sharp trade-off for the Federal Reserve: EITHER create a recession deep enough to get economic activity down to what the economy can sustain…

OR live with persistent inflation.

3: Aging to weigh on growth

Continued aging of the population will weigh on future growth.

If the productivity of each worker keeps increasing at the same rate as before, annual GDP growth would be roughly two-thirds of its average between 1980 and 2020. Now that’s some slow growth!

Outro frame: Here’s our Market take 

Here’s our Market take…

An aging workforce in the U.S. is a near-term and long-term labor constraint.  It’s one reason why we are underweight developed market equities for now and favor inflation-linked bonds.

Closing frame: Read details: 

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A stark trade-off

Aging has worsened labor shortages, raising the cost of taming inflation. We see the Federal Reserve living with some inflation, so we like inflation-linked bonds.

Market backdrop

Stocks edged higher, rallying 15% from October lows. They aren’t reflecting the recession we expect. The yield curve remains deeply inverted.

Week ahead

Labor supply is a major factor in determining the recession cost of trying to tame inflation. That’s why this week’s jobs data are key for the Fed and markets.

The share of the US population in work or seeking a job is still below pre-Covid levels. This shortfall won’t be made up: A bigger share of people are older than the normal retirement age – a major constraint. That makes it hard for the economy to operate at current activity levels without fueling inflation. The Fed would need to crush activity to push inflation back to its target. We see the Fed causing recession, with persistent inflation. We’re underweight stocks and like inflation-linked bonds.

Market commentary Asset class views
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Chart of the week

Aging behind workforce decline

Contribution of aging to fall in participation rate, 2008-2022

A red line shows that the participation rate, or the share of people aged 16 and over that have or are looking for work, nosedived when the pandemic hit and people left the workforce. A yellow line shows that an aging population is increasingly cutting into the participation rate

Sources: BlackRock Investment Institute, US Bureau of Labor Statistics, October 2022. Notes: The orange line shows the US labor force participation rate, defined as the share of the adult population (aged 16 and over) that is in work or actively looking for work. The yellow line shows how much the aging population has contributed to the participation rate decline since 2008, as calculated by fixing participation rates and changing the weights based on population data.

A smaller share of the US population is in the workforce than pre-Covid. That’s unlikely to change, we think. Why? The participation rate, or the share of people aged 16 and over that have or are looking for work, nosedived when the pandemic hit and people left the workforce (orange line in chart). Some of that sharp decline has been made up as people return. But we don’t see it recovering further because the effects of an aging population account for most of the remaining shortfall. More people have hit 64 years old, the age at which most retire. That’s taken 1.3 million out of the workforce as of October, we find. Another 630, 000 left as the pandemic caused fewer people to work past retirement age and hastened retirement for people coming up to 64. An aging population is increasingly cutting into the participation rate (yellow line) and shrinking the labor force.

These trends explain why the US participation rate is below its pre-Covid level and yet unemployment is still at a 50-year low. The share of the population aged over 64 has been increasing since 2010 and it’s set to keep rising. The effect of this demographic shift on participation won’t reverse without massive structural changes in workforce behavior over time, in our view. That implies the workforce will keep shrinking relative to the population. Economic activity will need to run at a lower level to avoid persistent wage and price inflation, especially in the labor-heavy services sector, in our view.

Inflation concerns

Interest rate hikes can’t cure production constraints like labor shortages. So the Fed today faces a sharp trade-off between either creating a recession to slam economic activity down to levels that the economy can more comfortably sustain or living with more persistent inflation. For now, the Fed seems to be trying to do the first, we think, with its “whatever it takes” stance trying to quickly stomp inflation down to its 2% target. In the face of production constraints, bringing inflation down to target would require a deep recession, in our view – a roughly 2% hit to activity. That’s why we think a recession is foretold. Yet we think the Fed will ultimately stop as the damage from rate hikes becomes clearer and before generating a deep recession. We think that means the US will be in a recession and still living with inflation persistently above target.

An aging population will hurt the US economy’s ability to grow without creating inflation longer term. A lower birth rate may eventually offset some of that effect as household formation and housing demand fall – but only after the costs tied to the aging baby boom generation play out. Demographic trends also suggest the labor pool will expand much more slowly in the next 20 years than it did in the past 20. If individual worker productivity keeps rising at the same rate, annual GDP growth would average just 1.8% – about two-thirds the average from 1980-2020 and the slowest 20-year period since data began.

What this means for investing

We stay overweight inflation-linked bonds because we think inflation will ease up but still be above the Fed’s target for some time. We’re underweight US stocks in the short term because they haven’t fully priced in the recession and corporate earnings downgrades we expect, especially as margin pressures mount from higher wages due in part to labor shortages. We’re also underweight Treasuries – long-term bond yields don’t reflect inflation’s persistence or that investors will demand more compensation for holding them as a result. We instead prefer attractive income in short-end bonds and high-quality credit. Long term, we’re overweight equities and think stocks’ overall return will surpass fixed income. Watch for our 2023 Global Outlook, out on Nov. 30, for more details on our views.

Market backdrop

US stocks edged higher last week, having rallied 15% from October lows. Long-term US Treasury yields fell, causing the yield curve to invert by the most since the early 1980s. We don’t think stocks are fully pricing in the recession we see from the Fed overtightening policy, even as US PMI data confirmed a deeper contraction in activity. We think the Fed will eventually stop its rate hikes next year, but we’re not expecting the swift rate cuts that the market is pricing in.

We’re watching the US labor market this week as worker shortages are a key production constraint.  Euro area inflation and unemployment data are also important given the European Central Bank’s latest hawkish rhetoric. Inflation remains stubbornly high, so we see the ECB pushing ahead with higher rates even as the economic damage becomes clearer.

Read our past weekly commentaries here.

Week ahead

The chart shows that Brent crude is the best performing asset year to date among a selected group of assets, while EM equities are 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 Nov. 24, 2022. 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 US dollars, and the rest in local currencies. Indexes or prices used are: spot Brent crude, ICE US Dollar Index (DXY), spot gold, MSCI Emerging Markets Index, MSCI Europe Index, Refinitiv Datastream 10-year benchmark government bond index (US, Germany and Italy), Bank of America Merrill Lynch Global High Yield Index, J.P. Morgan EMBI Index, Bank of America Merrill Lynch Global Broad Corporate Index and MSCI USA Index.

Nov. 29

US consumer confidence

Nov. 30

Euro area inflation; US job openings

Dec. 1

Euro area unemployment; US PCE

Dec. 2

US payrolls report

Investment themes

01

Bracing for volatility

The Great Moderation, a long period of steady growth and low inflation, has ended in our view. We see macro and market volatility reverberating through the new regime. What changed? Production constraints triggered by the pandemic and the war in Ukraine are pressuring the economy and inflation.

02

Living with inflation

We are in a new world shaped by supply. Major spending shifts and production constraints are driving inflation.

03

Positioning for net zero

Climate risk is investment risk, and the narrowing window for governments to reach net-zero goals means that investors need to start adapting their portfolios today. The net-zero journey is not just a 2050 story; it's a now story.

Directional views

Strategic (long-term) and tactical (6-12 month) views on broad asset classes, November 2022

Legend Granular

Asset Strategic view Tactical view Commentary
Equities Equities: strategic Overweight +2 Equities: tactical Underweight -1 We are overweight equities in our strategic views as we see central banks ultimately choosing to live with some inflation. Valuations on a long horizon do not appear stretched to us. Tactically, we’re underweight DM stocks as central banks look set to overtighten policy – we see recessions looming. Corporate earnings expectations have yet to fully reflect even a modest recession.
Credit Credit: strategic Overweight +1 Credit: tactical Overweight +1 Strategically, we add to our overweight to global investment grade on attractive valuations and income potential given higher yields. We turn neutral high yield as we see the asset class more vulnerable to recession risks. Tactically, we’re also overweight investment grade and neutral high yield. We prefer to be up in quality. We overweight local-currency EM debt on attractive valuations. A large risk premium compensates investors for inflation risk, in our view.
Government bonds Government bonds: strategic Underweight -1 Government bonds: tactical Underweight -1 The underweight in our strategic view on government bonds reflects a big spread: max underweight nominal, max overweight inflation-linked and an underweight on Chinese bonds. We think markets are underappreciating the persistence of high inflation and the implications for investors demanding a higher term premium. Tactically, we are underweight long-dated DM government bonds as we see term premium driving yields higher, yet we are neutral short-dated government bonds as we see a likely peak in pricing of policy rates. The high yields offer relatively attractive income opportunities.
Private markets Private markets: strategic Underweight -1 - We’re underweight private growth assets and neutral on private credit, from a starting allocation that is much larger than what most qualified investors hold. Private assets are not immune to higher macro and market volatility or higher rates, and public market selloffs have reduced their relative appeal. Private allocations are long-term commitments, however, and we see opportunities as assets reprice over time. Private markets are a complex asset class not suitable for all investors.

Note: Views are from a US dollar perspective. 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, November 2022

Legend Granular

Asset Tactical view Commentary
Equities
Developed markets Developed markets: tactical Underweight -1 We are underweight DM stocks on a worsening macro picture and risks to corporate profit margins from higher costs. Central banks appear set on reining in inflation by crushing growth – increasing the risk of the post-Covid restart being derailed.
United States United States: tactical Underweight -1 We are underweight US equities. The Fed intends to raise rates into restrictive territory. The year-to-date selloff partly reflects this. Yet valuations have not come down enough to reflect weaker earnings prospects.
Europe Europe: tactical Underweight -1 We are underweight European equities as the fresh energy price shock in the aftermath of the tragic war in Ukraine puts the region at risk of stagflation.
U.K. U.K.: tactical Underweight -1 We are underweight UK equities following their strong performance versus other DM markets thanks to energy sector exposure.
Japan Japan: tactical Neutral We are neutral Japan stocks. We like still-easy monetary policy and increasing dividend payouts. Slowing global growth is a risk.
China China: tactical Neutral We are neutral Chinese equities. Activity is restarting, but we see 2022 growth below official targets. Geopolitical concerns around China’s ties to Russia warrant higher risk premia, we think.
Emerging markets Emerging markets: tactical Neutral We are neutral EM equities on the back of slowing global growth. Within the asset classes, we lean toward commodity exporters over importers.
Asia ex-Japan Asia ex-Japan: tactical Neutral We are neutral Asia ex-Japan equities. China’s near-term cyclical rebound is a positive yet we don’t see valuations compelling enough to turn overweight.
Fixed income
US Treasuries US Treasuries: tactical Underweight -1 We are underweight US Treasuries even with the yield surge. We see long-term yields moving up further as investors demand a greater term premium. Attractive carry spurs a preference for short-maturity bonds.
Global inflation-linked bonds Global inflation-linked bonds: tactical Overweight +1 We are overweight global inflation-linked bonds and prefer Europe. The pullback in euro area breakeven rates since May suggests markets are underappreciating the inflationary pressures from the energy shock.
European government bonds European government bonds: tactical Neutral We are neutral European government bonds. We think market pricing of euro area rate hikes is too hawkish.
UK Gilts UK Gilts: tactical Underweight -1 We are neutral UK gilts. Perceptions of fiscal credibility have improved, though not fully, after a reversal of planned fiscal stimulus. We think the BoE will have to hike rates less than we assumed immediately after the Sept. 23 “mini budget.”
China government bonds China government bonds: tactical Neutral We are neutral Chinese government bonds as policymakers have been slow to loosen policy to offset the slowdown, and they are less attractive than DM bonds.
Global investment grade Global investment grade: tactical Overweight +1 We are overweight investment grade credit. High quality corporates’ strong balance sheets imply IG credit could weather weaker growth better than stocks.
Global high yield Global high yield: tactical Neutral We are neutral high yield. We prefer up-in-quality credit exposures amid a worsening macro backdrop. We think parts of high yield offer attractive income.
Emerging market - hard currency Emerging market - hard currency: tactical Neutral We are neutral hard-currency EM debt. We expect it to gain support from higher commodities prices but remain vulnerable to rising US yields.
Emerging market - local currency Emerging market - local currency: tactical Overweight +1 We are modestly overweight local-currency EM debt on attractive valuations and potential income. Higher yields already reflect EM monetary policy tightening, in our view, and offer compensation for inflation risk.
Asia fixed income Asia fixed income: tactical Neutral We are neutral Asia fixed income amid a worsening macro outlook. We don’t find valuations compelling enough yet to turn more positive on the asset class.

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 US 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.

Euro-denominated tactical granular views

Six to 12-month tactical views on selected assets vs. broad global asset classes by level of conviction, November 2022

Legend Granular

Asset Tactical view Commentary
Equities
 Europe ex UK Europe ex-UK: tactical Underweight -1 We are underweight European equities. We don’t think consensus earnings expectations are pricing in heightened risks of a deep recession. We see a sharp hit to euro area growth from the energy price shock alone. The European Central Bank looks intent on squeezing out inflation via higher rates – another drag on activity.
Germany Germany: tactical Neutral We are neutral German equities. While valuations are supportive relative to peers, near-term headwinds to earnings prospects remain significant amid tense gas supplies, rapid ECB tightening and slower growth of major trading partners. Looking further ahead, opportunities arise from political ambitions to bring the economy to net zero.
France France: tactical Underweight -1 We are underweight French equities. France’s more favourable energy mix and the stock market’s tilt to energy could help insulate portfolios against elevated inflation. High electricity prices put pressure on corporate margins, though, despite policy relief. The pace of structural reforms looks set to slow following the parliamentary elections.
Italy Italy: tactical Underweight -1 We are underweight Italian equities. The economy’s relatively weak credit fundamentals amid tightening financial conditions globally keep us cautious.
Spain Spain: tactical Underweight -1 We are underweight Spanish equities. The market’s outperformance in 2022 – driven largely by its greater relative exposure to  rate-sensitive financials – leave it vulnerable, in our view, to profit-taking amid a broader, regional downturn on slowing growth.
Switzerland UK: tactical Underweight -1 We are neutral Swiss equities. The equity benchmark sports a defensive tilt with high sector weights to health care and consumer goods, providing a cushion amid heightened uncertainty over the global macro outlook.
UK UK: tactical Neutral We are underweight UK equities. We see UK growth slowing sharply – as explicitly acknowledged by the Bank of England and yet not reflected in consensus earnings expectations. The market – that has outperformed other DMs in 2022 due to energy sector exposure – is not immune to a global downturn.
Fixed income
Euro area government bonds Euro area government bonds: tactical Neutral We are neutral nominal European government bonds. Market pricing of ECB policy is too hawkish, we think, given looming recession. The end of ECB net asset purchases, likely issuance to support fiscal policies and our view of elevated inflation keeps us from turning positive and underpins our preference for inflation-linked bonds.
German bunds German bunds: tactical Neutral Weare neutral German bunds. Further upward pressure on yields appears limited to us given hawkish ECB policy expectations even with rising recessionary risks, elevated – yet possibly peaking – headline inflation, and lingering geopolitical uncertainty.
French OATs French OATs: tactical Neutral We are neutral French government bonds. ECB policy expectations appear too hawkish as recession nears. Elevated French public debt and a slower pace of structural reforms remain headwinds.
Italian BTPs Italian BTPs: tactical Underweight -1 We have a modest underweight on Italian BTPs. Spreads have already widened this year, yet we stay cautious given weaker credit fundamentals, global policy tightening and lingering political uncertainty. The ECB’s Transmission Protection Instrument – a bond purchase scheme – offers a backstop.
Swiss government bonds Swiss government bonds: tactical Neutral We are neutral Swiss bonds. The Swiss National Bank has quickly moved its policy rate into positive territory despite the highly valued Franc. Further upward pressure on yields appears limited, though, in light of lingering uncertainties and still comparatively subdued underlying inflation pressure.
UK gilts Swiss government bonds: tactical Neutral We are neutral UK gilts. Perceptions of fiscal credibility have improved, though not fully, after a reversal of planned fiscal stimulus. We think the BoE will have to hike rates less than we assumed immediately after the Sept. 23 “mini budget.”
European inflation-protected securities European inflation-protected securities: tactical Overweight +1 We are overweight European inflation-protected government bonds because we see persistent inflation and the ECB ultimately living with higher levels of it. Weaning off Russian fossil fuels is likely to keep energy inflation high in the medium term. The short-term impact will be even more severe if Russia cuts off the gas supply.
European investment grade credit European investment grade credit: tactical Overweight +1 We are overweight investment-grade credit. We find valuations attractive in terms of both overall yield and the spread vs. government bonds. Coupon income is the highest in about a decade.
European high yield European high yield: tactical Neutral We are neutral high yield. We find the income potential attractive, yet prefer up-in-quality credit exposures amid a worsening macro backdrop.

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 euro perspective, October 2022. 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.

Jean Boivin
Jean Boivin
Head – BlackRock Investment Institute
Wei Li
Wei Li
Deputy Head – BlackRock Investment Institute
Alex Brazier
Alex Brazier
Deputy Head – BlackRock Investment Institute
Nicholas Fawcett
Nicholas Fawcett
Macro research – BlackRock Investment Institute

This material is for distribution to Professional Clients (as defined by the FCA Rules) and should not be relied upon by any other persons.

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Sources: Bloomberg unless otherwise specified.

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