GLOBAL WEEKLY COMMENTARY

Virus spike to delay, not derail restart

Key points

Omicron strikes
We see Omicron delaying – but not derailing – the powerful activity restart even as its impact will differ by country. We keep favoring equities as a result.
Market backdrop
Stocks and bonds fell after the Fed indicated a potentially faster-than-expected normalization. We think it’s still important to look through the knee-jerk reaction
Week ahead
Investors will get a read on the persistence of U.S. inflation this week, while Chinese credit data may provide clues on the speed of policy loosening.

The new year has started with a record COVID surge, renewed restrictions and many people working from home again. The difference with this time: The Omicron strain appears less severe in populations with high vaccination and immunity rates. We see Omicron delaying – and not derailing - the powerful restart of economic activity while potentially adding to supply bottlenecks. We stay overweight equities and eye risks that policymakers or markets misread the current surge in inflation. 

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A less severe virus strain

London COVID-19 cases and hospital admissions vs. previous peaks, 2020-2022

This chart shows that although virus cases in the U.K. have spiraled upward while hospital admissions have remained 50% below its earlier peak.

Past performance is not a reliable indicator of current or future results. Indexes are unmanaged and not subject to fees. It is not possible to invest directly in an index. Sources: BlackRock Investment Institute, with data from UK Coronavirus (COVID-19) Dashboard . Notes: Chart shows London COVID-19 cases and hospital admissions compared with their January 2021 peak level. Hospital admission data are adjusted by seven days to account for the lag between cases and admissions.

Markets have started the new year on a jittery note, with worries centering on Fed rate rises and policy normalization. We urged investors to stay invested through COVID-related volatility as we believed the strain would ultimately only delay the powerful restart of economic activity that has underpinned a surge in corporate profits. More clarity on Omicron in the past weeks has strengthened our conviction, even as the COVID surge may look frightening. Why? First, vaccines and prior infections have proven effective against severe disease even as their efficacy against Omicron infection has fallen. Second, scientific studies are suggesting Omicron is intrinsically somewhat less severe than previous strains. Third, populations have gained higher immunity as more people have caught COVID or received boosters. All this suggests a surge in cases but a more muted rise in hospitalizations. We view the situation in the recent Omicron hot spot of London  as a harbinger of things to come. Case loads spiraled upward to almost double the previous peak in early 2021 (the red line in the chart). Yet hospital admissions have remained 50% below the earlier highwater mark (the yellow line). 

Both case loads and hospitalizations in London have started to come down, suggesting the worst of the Omicron wave may be over. We expect other areas to follow a similar pattern over the next couple of months. The caveats: Outcomes will likely be worse elsewhere as the UK sports high vaccination, booster and immunity rates. And pressure on hospitals and services in general is set to mount as they already face staff shortages. Check out our COVID-19 tracker for the latest trends.

The key question is how China’s zero-COVID policy will stand up against Omicron. The policy so far has proven effective and enjoyed popular support, but has left China with almost no natural immunity. We expect the country to maintain the policy – at least optically – in this politically important year. This raises the spectre of more restrictions on activity, from targeted measures that keep the economy humming (Shanghai)  to full-scale lockdowns (Xi’an). As a result, we believe downside risks to China’s growth have risen, even as Beijing appears bent on achieving its growth target this year by loosening policy. The big picture on Omicron remains that we see it only delay the powerful global restart. Less growth now means more growth later, in our view. Omicron also may have a silver lining. Its highly infectious nature may turn COVID into an endemic disease similar to the flu as populations build up immunity and annual booster shots keep down the human toll.

Risk assets showed clear concern about the Fed over Omicron last week. Policymakers and markets may misread the unique mix of the restart, a mutating virus, supply-driven inflation and new central bank policies. Our base case: Central banks take their foot off the gas pedal to move away from emergency stimulus. We expect them to live with inflation, rather than hit the brakes by raising rates to restrictive levels. The Fed has signaled three rate rises this year – more than we expected. Markets seem primed to equate higher rates as being negative for equities. We’ve seen this before and don’t agree. What really matters is that the Fed has kept signaling a low sum total of rate hikes, and that didn’t change last week. This historically muted response to inflation should keep real policy rates low, in our view, supporting equities. And not all spikes in long-term yields are the same. Last week’s jump in U.S. Treasury yields was about the Fed signaling a readiness to start shrinking its balance sheet. This could result in a return of term premium that typically demand to hold long-term bonds. But this is not necessarily negative for risk assets but can reflect an investor preference for equities over government bonds. Our bottom line: We prefer equities and would use COVID-related selloffs to add to risk. We are underweight DM government bonds – we see yields gradually heading higher but staying historically low.

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Employment key to start of Fed hikes
Employment in the U.S. is recovering, gradually removing the final hurdle for the Federal Reserve to kick off rate increases. Learn more in our macro insights.
BlackRock Investment Institute Macro insights

Assets in review

Selected asset performance, 12 month return and range

 The chart shows that Brent crude oil is the best performing asset over the past 12 months among a selected group of assets, while 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 January 7, 2022. Notes: The two ends of the bars show the lowest and highest returns at any point over the last 12-months and the dots represent current 12-month  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), MSCI Emerging Markets Index, Bank of America Merrill Lynch Global High Yield Index, J.P. Morgan EMBI Index, spot gold, Refinitiv Datastream Italy 10-year benchmark government bond index, Bank of America Merrill Lynch Global Broad Corporate Index, Refinitiv Datastream Germany 10-year benchmark government bond index and Refinitiv Datastream U.S. 10-year benchmark government bond index.

Market backdrop

Stocks and bonds fell after minutes from the Fed’s December meeting indicated a potentially faster-than-expected policy normalization, including speeding up the timeline for trimming its bond portfolio. The big picture remains that major central banks have indicated a historically muted response to rising inflation. This should keep real yields negative and support equities. We see inflation settling at a level higher than pre-COVID even as pressures from supply bottlenecks ease.

Week ahead

Jan. 10-17  – China money and credit data; Euro area unemployment rate
Jan. 12 China and U.S. CPI inflation data
Jan. 14 U.S. industrial production and University of Michigan sentiment

Investors will get a read on the persistence of U.S. consumer price inflation this week, while Chinese credit data may provide clues on the speed of policy loosening. The powerful economic restart has driven U.S. inflation rates to its highest rate in decades. This means the Federal Reserve has clearly met its average inflation target under its new framework, helping open the door for interest rate rises this year.

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Directional views

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

Note: Views are from a U.S. dollar perspective, December 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, January 2022

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 details about our investment themes and more in our 2022 Global outlook.

Living with inflation

 

We expect inflation to be persistent and settle above pre-Covid levels. We expect central banks to kick off rate hikes but remain more tolerant of price pressures, keeping real interest rates historically low and supportive of risk assets.

    • Inflation is being driven by the unusual restart dynamics of extraordinary demand bumping up against supply bottlenecks. We expect many supply-demand imbalances to resolve over the year.
    • The policy response to rising inflation isn’t uniform. The Fed and the ECB are more tolerant of inflation, even as the Fed has started to warn of inflation risks.
    • Other developed market (DM) central banks have signaled policy rate paths with steeper initial increases, and many of their emerging market (EM) counterparts have already lifted off.
    • The Fed has achieved its new inflation goal to make up for past misses and sees full employment being reached this year. This is the justification for the three rate hikes it has suggested for 2022. This is more than we expected, but we believe the total sum of hikes is unchanged and historically muted – and more important to markets.
    • The Fed has sped up its tapering of bond purchases and has indicated it may start to trim its balance sheet earlier than expected by letting bonds run off when they mature.
    • Investment implication: We prefer equities over fixed income and remain overweight inflation-linked bonds.
Cutting through confusion

 

A unique mix of events - the restart of economic activity, virus strains, supply driven inflation and new central bank frameworks - could cause markets and policymakers to misread the current surge in inflation.

    • We keep the big picture in mind: We see the restart rolling on, inflation meeting a muted central bank response, and real rates remaining historically low.
    • We do see increasing risks around this base case: Central banks could revert to their old policy response, and growth could surprise on the upside or disappoint.
    • There’s also a risk markets misread China’s policy. The country has emphasized social objectives and quality growth over quantity in regulatory crackdowns that have spooked some investors. Yet policymakers can no longer ignore the growth slowdown, and we expect incremental loosening across three pillars - monetary, fiscal and regulatory.
    • Investment implication: We have trimmed risk-taking amid an unusually wide range of outcomes.
Navigating 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.

    • Sustainability cuts across multiple dimensions: the outlook for inflation, geopolitics and policy. The green transition comes with costs and higher inflation, yet the economic outlook is unambiguously brighter than a scenario of no climate action or a disorderly transition. Both would generate lower growth and higher inflation, in our view.
    • Risks around a disorderly transition are high – particularly if execution fails to match governments’ ambitions to cut emissions.
    • We favor sectors with clear transition plans. Over a strategic horizon, we like the sectors that stand to benefit more from the transition, such as tech and healthcare, because of their relatively low carbon emissions.
    • Investment implication: We favor DM equities over EM as we see them as better positioned in the green transition.

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Wei Li
Wei Li
Global Chief Investment Strategist - BlackRock Investment Institute
Alex Brazier
Deputy Head – BlackRock Investment Institute
Yu Song
Chief China Economist – BlackRock Investment Institute
Paolo Puggioni
Data and Innovation Manager – BlackRock Fundamental Equity
Michel Dilmanian
Member of Investment Strategy team - BlackRock Investment Institute