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Aging raises cost of curbing inflation

Market take

Weekly video_20221128

Nicholas Fawcett

Opening frame: What’s driving markets? Market take

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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: 

www.blackrock.com/weekly-commentary

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 more than 10% 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 U.S. 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.

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Investment themes

01

Bracing for volatility

We have entered a regime of higher macro and market volatility. This implies that market views may have to change more quickly and get more granular.

02

Living with inflation

We see the Fed ultimately living with higher inflation as it sees the effect of its rate hikes on growth and jobs. For now, the Fed seems to be responding solely to the politics of inflation. This has caused us to reduce portfolio risk.

03

Positioning for net zero

Investing in high-carbon-emitting companies with credible transition plans or that are key to the transition can give investors exposure to the transition as well as mitigate the impact of its bumps.

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, U.S. Bureau of Labor Statistics, October 2022. Notes: The orange line shows the U.S. 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 U.S. 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 U.S. 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 U.S. will be in a recession and still living with inflation persistently above target.

An aging population will hurt the U.S. 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 U.S. 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

U.S. stocks edged higher last week, having rallied 15% from October lows. Long-term U.S. 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 U.S. 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 U.S. 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.

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 U.S. dollars, and the rest in local currencies. Indexes or prices used are: spot Brent crude, ICE U.S. Dollar Index (DXY), spot gold, MSCI Emerging Markets Index, MSCI Europe Index, Refinitiv Datastream 10-year benchmark government bond index (U.S., 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

U.S. consumer confidence

Nov. 30

Euro area inflation; U.S. job openings

Dec. 1

Euro area unemployment; U.S. PCE

Dec. 2

U.S. payrolls report

Read our past weekly market commentaries here.

 

Directional views

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

Asset Strategic view Tactical view Commentary
Equities Equities: strategic Overweight +1 Equities: tactical Underweight -1 We are overweight equities in our strategic views as we estimate the overall return of stocks will be greater than fixed-income assets over the coming decade. 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: strategic Overweight +1 Strategically, we add to our overweight to global investment grade credit on attractive valuations and income potential given higher yields. We turn neutral high yield as we see the asset class as more vulnerable to recession risks. Tactically, we’re also overweight investment grade and neutral high yield. We prefer to be up in quality. We cut EM debt to neutral after its strong run. We see better opportunities for income in DMs.
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 U.S. dollar perspective, November 2022. 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.

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

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.

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

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, November 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
Head – BlackRock Investment Institute
Wei Li
Global Chief Investment Strategist – BlackRock Investment Institute
Alex Brazier
Deputy Head – BlackRock Investment Institute
Nicholas Fawcett
Macro research – BlackRock Investment Institute