BLACKROCK INVESTMENT INSTITUTE

Debt ceiling spat takes a breather

We still see a low risk of technical default by the US and expect the debt ceiling debacle to ultimately resolve. The broadening economic restart keeps us tactically pro-risk, yet we see a narrowing path for risk assets to push higher and markets more prone to temporary pullbacks. Key events toward the year end, including the lapse of the temporary debt ceiling rise, could potentially trigger market volatility. We favour looking through market jitters against the backdrop of the restart.

Key points

A low risk of default
We believe the debt ceiling dispute will eventually resolve but could trigger more volatility. The broadening economic restart keeps us tactically pro-risk.
Market backdrop
US job growth slowed sharply in September, but we see it as unlikely to affect the Fed’s taper plan. The Senate reached a deal on a temporary debt ceiling rise.
Week ahead
US inflation data will be in focus as price pressure has appeared to be more persistent than expected and broadened beyond pandemic-related items.
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Chart of the week
Google searches using the key phrase “debt ceiling,” 2009-2021

Google searches using the key phrase “debt ceiling,” 2009-2021

Sources: BlackRock Investment Institute, with data from Google, October 2021. Notes: Interest over time  shows search interest relative to the highest point on the chart for the given time, according to Google. A value of 100 is the peak popularity for the term. A value of 50 means that the term is half as popular. A score of zero means there was not enough data for this term.

The showdown around the debt ceiling – a self-imposed federal borrowing limit - has kept investors on their toes. The debt ceiling has become a subject of intense partisan wrangling over recent decades, with negotiations going down the wire in 2011 and 2013. Google searches on the key phrase “debt ceiling” have surged to the highest level since the 2013. See the chart above. In recent months the impasse has led to market jitters, especially after risk assets have had an extended run higher. The front end of Treasury yield curve – a popular gauge of market sentiment on the issue – had shot up until the Senate struck a deal to temporarily raise the debt ceiling last week. Yet there is more political squabble to come toward the year end. The US government could once again near a technical default around the time when the temporary government funding is set to lapse if Congress fails to approve new spending legislation and raise the debt ceiling. Democrats have yet to unify behind their multi-trillion-dollar spending plans on infrastructure, social policy and climate change.

The temporary debt ceiling increase will likely allow the Democratic Party to focus on rallying its members in Congress around the spending plans – key legislative priorities ahead of the 2022 midterm elections. As expected, the $3.5 trillion price tag of the bill on social policy and climate change is being scaled down to help ensure the support of party moderates.

A smaller package means a reduced amount of revenue needed to offset spending. The tax proposals from the House Ways and Means Committee prior to the latest effort among Democrats to scale down the plan already showed moderated tax increases. This includes a proposed rise in the corporate tax rate to 26.5%, down from 28% in the original proposal. It also showed an increase in the Global Intangible Low Tax Income (GILTI) tax – intended to discourage corporations from moving profits overseas – to 16.5%, down from 21%. This increase would be line with the new global minimum tax agreement that aims to achieve the same goal. We are tactically neutral US equities as we see large caps as exposed to risks of higher taxes and tighter regulation. The tax increases will likely have the largest impact on financials and communication services, in our view, but any further watering down of the proposed tax increases would reduce the headwind for these sectors.

The debt ceiling debate recently has triggered headlines and volatility, and we believe markets generally are increasingly susceptible to swings in sentiment. This includes supply-driven price spikes in energy and other prices awaking fears of runaway inflation and central bank actions to suppress it. We see the price spikes as mostly related to the powerful economic restart and therefore not permanent, but recognize inflation narratives can easily take hold of markets.

The bottom line: We continue to see a low risk of a technical default by the US government, and expect a downsized spending package and related tax increases. The debt ceiling showdown may return in December, yet we believe it will ultimately be resolved and prefer to look through potential market volatility. Political brinkmanship could lead to a short-lived government shutdown and reignite concerns of a technical default. We are tactically neutral US equities as we see US growth momentum peaking and expect other regions to benefit more from the broadening economic restart. We are strongly underweight US Treasuries as we see a gradual rise in nominal yields even with the Fed poised to start tapering by the end of the year. We are tactically pro-risk, yet recognize the path for further gains in risk assets has narrowed after an extended run higher and that markets have become more susceptible to sentiment swings.

Supply chain crunch amid the restart
Supply chain disruptions could persist into near year. Read more in our macro insights.
Eyes on inflation

Assets in review
Selected asset performance, 2021 year-to-date and range

The chart shows that Brent crude oil is the best performing asset so far this year among a selected group of assets, while spot 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 Oct. 7, 2021. 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, in descending order: spot Brent crude, MSCI USA Index , MSCI Europe Index, ICE US Dollar Index (DXY), Bank of America Merrill Lynch Global High Yield Index, MSCI Emerging Markets Index, Refinitiv Datastream Italy 10-year benchmark government bond index, J.P. Morgan EMBI Index, Bank of America Merrill Lynch Global Broad Corporate Index, Refinitiv Datastream Germany 10-year benchmark government bond index, Refinitiv Datastream US 10-year benchmark government bond index and spot gold.

US nonfarm payrolls growth slowed sharply in September due to the delta variant surge. US stocks reversed the previous week’s decline after the Senate agreed to temporarily raise the debt ceiling. US 10-year Treasury rose to the highest level since June. We view the recent yield backup as correcting a disconnect between the restart and earlier yield levels, rather than foreshadowing a more drastic yield rise. Stronger-than-expected activity data and more hawkish signals from policymakers have shifted the market consensus on the Bank of England’s interest rate liftoff to the first quarter of 2022.

Week ahead

Oct. 11-18 China total social financing and new yuan loans
Oct. 13 US consumer price index (CPI)
Oct. 14 US producer price index (PPI); China CPI, PPI
Oct. 15 University of Michigan Surveys of Consumers

US inflation data will be in focus this week. Consumer prices increased at their slowest pace in six months in August as prices of some items related to the Covid shock had subsided, though inflationary pressure had broadened beyond pandemic-related items. Consensus forecast sees a 5.4% annual increase, compared with a 5.3% rise in the previous month, according to Reuters.

Directional views

Strategic (long-term) and tactical (6-12 month) views on broad asset classes, October 2021

Legend Granular

Note: Views are from a US dollar perspective, October 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, October 2021

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.

Read details about our investment themes and more in our 2021 Global outlook.

Growth edges up

 

The powerful restart of economic activity has broadened, with Europe and other major economies catching up with the US We expect a higher inflation regime in the medium term. We see the Fed normalising policy rates only in 2023 and the European Central Bank standing pat for much longer.

    • The new nominal has largely unfolded in 2021: the rise in long-term yields has been mainly driven by higher market pricing of inflation, with real yields remaining pinned well in negative territory.
    • The Fed has signalled that it is gearing up to start tapering around the end of the year. It appears reluctant to confirm its inflation mandate has been met, and this reinforces our new nominal theme.
    • The ECB has made a significant change to its monetary policy framework by adopting a symmetric inflation target of 2%. We believe this is part of a global trend to relax the constraints in earlier frameworks preventing looser policy.
    • Tactical implication: We are overweight European equities and inflation-linked bonds. We are neutral on US equities. We upgrade EM local-currency debt to modest overweight.​
    • Strategic implication: We remain underweight DM government bonds and prefer equities over credit.
Policy Pause

 

China is on the path toward greater role of state where social objectives will have primacy over quantity of growth. Yet the growth slowdown has hit levels policymakers can no longer ignore and we expect to see incremental loosening across three pillars - monetary, fiscal and regulatory.

    • We believe investors should be mindful of ongoing geopolitical tensions, which was underscored by the uncertainty around China’s clampdown on certain industries.
    • Tactical implication: We turn modestly positive on Chinese equities, and maintain an overweight on its debt.​
    • Strategic implication: Given the small benchmark weights and typical client allocation to Chinese assets, allocation would have to increase by multiples before they represent a bullish bet on China, and even more for government bonds.
Raising resilience

 

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 full consequences of the tectonic shift to sustainability are not yet in market prices, in our view. The path is unlikely to be a smooth one – and we see this creating opportunities across investment horizons. ​
    • Certain commodities, such as copper and lithium, will likely see increased demand from the drive to net zero. Yet we think it’s important to distinguish between near-term price drivers of some commodities – notably the economic restart – and the long-term transition that will matter to prices.
    • Climate risk is investment risk, and we also see it as a historic investment opportunity. Our long-run return assumptions now reflect the impact of climate change and use sectors as the relevant unit of investment analysis.
    • Tactical implication: We are overweight the tech sector as we believe it is better positioned for the green transition.​
    • Strategic implication: We like DM equities and the tech sector as a way to play the climate transition.​
Wei Li
Global Chief Investment Strategist – BlackRock Investment Institute
Elga Bartsch
Head of Macro Research — BlackRock Investment Institute
Kurt Reiman
Senior Strategist for North America – BlackRock Investment Institute

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