Global Weekly Commentary: 2022’s big change: Fed hikes rates
Key points
2022's big change
The Federal Reserve will join other central banks in raising rates for the first time since the pandemic began. We expect a historically muted response to inflation.
Stock gains, bond losses
Stocks posted solid gains and bonds fell in 2021 – a pattern seen only in a few years since 1977. We see a repeat in 2022, albeit with moderating equity returns.
Week ahead
U.S. employment data are in focus this week as they play into the timing and path of the Fed’s rate hikes. PMI data will give a read on the restart’s momentum.
Last year saw central banks living with inflation. This higher tolerance for price pressures, and the powerful economic restart, kept risk assets buoyant and limited the rise in yields. How central banks - particularly the Fed - respond to inflation will be the key story for 2022, in our view. We expect the Fed to raise rates but see its cumulative response to inflation as more muted than ever before. Yet the possibility that policymakers or investors misread the situation prompts us to trim risk.
A historically muted response
Fed funds rate vs. historical response and expectations, 2018-2025
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 Bloomberg, December 2021. Notes:: The chart shows the U.S. nominal federal funds rate (orange line), the projected path implied by the dot plot in the U.S. Federal Reserve’s latest Summary of Economic projections (yellow diamonds) and the path implied by market pricing. The green dotted line shows the path that would have been implied by a monetary policy rule linking the choice of policy rate to the rate of inflation and the level of the output gap.
2021’s powerful restart of economic activity resulted in severe price pressures and supply bottlenecks. In a stark departure from past practice of pre-emptive tightening, most developed market (DM) central banks did not respond when inflation and growth surged. Nominal bond yields rose, but not as much as inflation. This kept real yields deeply negative and supported equities, the hallmarks of our 2021 new nominal investment theme. The next phase of this story is playing out now. Most central banks are poised to nudge up policy rates – but this is taking the foot off the monetary accelerator, not hitting the brakes. We don’t see them responding aggressively to persistent inflation. Case in point: the Fed. It signaled three rate increases this year at its December meeting, noting high inflation, strong growth and labor market improvements. This is more than we expected, but what matters is the sum total of rate hikes. The Fed’s indicated policy response (yellow dots in the chart) is very mild compared with how it would deal with inflation in the past: a series of rapid-fire rate hikes that would have already began and would hoist the fed funds rate to near 4% over time (dotted green line).
In developed economies, we see the European Central Bank (ECB) keeping its foot on the accelerator while others such as the Fed prepare to pull back slightly. Importantly, no one is contemplating hitting the brakes – a factor for our modestly pro-equities stance and upgrade to U.S. equities. What matters next is whether DM central banks think their respective labor markets have returned to pre-Covid trends. Why? They may have an explicit employment mandate, like the Fed, or they use labor market conditions as a gauge for future inflationary pressures. This will play into the timing, pace and end point of policy hikes.
As we note in our 2022 Global Outlook, a unique confluence of events – the restart, new virus strains, supply-driven inflation and new central bank frameworks – are creating confusion as there are no historical parallels. Cutting through this confusion is key which is why we assess alternative scenarios to our base outcome and trim risk.
What are the risks to our base case? One is a delayed activity restart due to a global resurgence in Covid-19 infections. This could be particularly acute in China if its zero-Covid approach results in repeated activity shutdowns. We expect the People’s Bank of China to keep policy looser as a result, a shift already underway after last year’s economic slowdown.
We see two other risks, both negative for risk assets and fixed income. Central banks could revert to previous policy responses in the face of persistent inflation pressures. The Bank of England (BoE) – which in December became the first major DM central bank to raise rates since the pandemic struck – has made the most noise about responding more aggressively to inflation, leading markets to expect repeated rate hikes. The BoE may serve as a test case of a DM central bank coming closer to hitting the brakes, prompting the market to price in a risk of a policy reversal on rates by 2024. And inflation expectations could become unanchored from policy targets in the post-Covid confusion, forcing central banks to react aggressively. This could lead to stagflation: higher inflation becoming sticky amid stagnating activity. Understanding these potential outcomes around inflation and the market implications is key to cutting through confusion outlook theme.
Our bottom line: We expect interest rates to end at a lower level than in the past given higher inflation. That matters more for markets than what rates are going to do next year, in our view. We see the higher inflation regime and solid growth as positive for risk assets but bad for bonds for a second consecutive year – the new regime highlighted in our 2022 outlook.
© 2021 BlackRock, Inc. All rights reserved.
General disclosure: This material is intended for information purposes only, and does not constitute investment advice, a recommendation or an offer or solicitation to purchase or sell any securities to any person in any jurisdiction in which an offer, solicitation, purchase or sale would be unlawful under the securities laws of such jurisdiction. The opinions expressed are as of January 3, 2022 and are subject to change without notice. Reliance upon information in this material is at the sole discretion of the reader. Investing involves risks.
In the U.S. and Canada, this material is intended for public distribution. In EMEA Until 31 December 2020, issued by BlackRock Investment Management (UK) Limited, authorized and regulated by the Financial Conduct Authority. Registered office: 12 Throgmorton Avenue, London, EC2N 2DL. Tel: + 44 (0)20 7743 3000. Registered in England and Wales No. 2020394, has issued this document for access by Professional Clients only and no other person should rely upon the information contained within it. For your protection telephone calls are usually recorded. Please refer to the Financial Conduct Authority website for a list of authorized activities conducted by BlackRock. From 1 January 2021, in the event the United Kingdom and the European Union do not enter into an arrangement which permits United Kingdom firms to offer and provide financial services into the European Union, the issuer of this material is:(i) BlackRock Investment Management (UK) Limited for all outside of the European Union; and(ii) BlackRock (Netherlands) B.V. for in the European Union, BlackRock (Netherlands) B.V. is authorized and regulated by the Netherlands Authority for the Financial Markets. Registered office Amstelplein 1, 1096 HA, Amsterdam, Tel: 020 – 549 5200, Tel: 31-20-549-5200. Trade Register No. 17068311 For your protection telephone calls are usually recorded. In Switzerland, for qualified investors in Switzerland: This document is marketing material. Until 31 December 2021, this document shall be exclusively made available to, and directed at, qualified investors as defined in the Swiss Collective Investment Schemes Act of 23 June 2006 (“CISA”), as amended. From 1 January 2022, this document shall be exclusively made available to, and directed at, qualified investors as defined in Article 10 (3) of the CISA of 23 June 2006, as amended, at the exclusion of qualified investors with an opting-out pursuant to Art. 5 (1) of the Swiss Federal Act on Financial Services ("FinSA"). For information on art. 8 / 9 Financial Services Act (FinSA) and on your client segmentation under art. 4 FinSA, please see the following website: www.blackrock.com/finsa. For investors in Israel: BlackRock Investment Management (UK) Limited is not licensed under Israel’s Regulation of Investment Advice, Investment Marketing and Portfolio Management Law, 5755-1995 (the “Advice Law”), nor does it carry insurance thereunder. In South Africa, please be advised that BlackRock Investment Management (UK) Limited is an authorized financial services provider with the South African Financial Services Board, FSP No. 43288. In the DIFC this material can be distributed in and from the Dubai International Financial Centre (DIFC) by BlackRock Advisors (UK) Limited — Dubai Branch which is regulated by the Dubai Financial Services Authority (DFSA). This material is only directed at 'Professional Clients’ and no other person should rely upon the information contained within it. Blackrock Advisors (UK) Limited - Dubai Branch is a DIFC Foreign Recognised Company registered with the DIFC Registrar of Companies (DIFC Registered Number 546), with its office at Unit 06/07, Level 1, Al Fattan Currency House, DIFC, PO Box 506661, Dubai, UAE, and is regulated by the DFSA to engage in the regulated activities of ‘Advising on Financial Products’ and ‘Arranging Deals in Investments’ in or from the DIFC, both of which are limited to units in a collective investment fund (DFSA Reference Number F000738). In the Kingdom of Saudi Arabia, issued in the Kingdom of Saudi Arabia (KSA) by BlackRock Saudi Arabia (BSA), authorized and regulated by the Capital Market Authority (CMA), License No. 18-192-30. Registered under the laws of KSA. Registered office: 29th floor, Olaya Towers – Tower B, 3074 Prince Mohammed bin Abdulaziz St., Olaya District, Riyadh 12213 – 8022, KSA, Tel: +966 11 838 3600. The information contained within is intended strictly for Sophisticated Investors as defined in the CMA Implementing Regulations. Neither the CMA or any other authority or regulator located in KSA has approved this information. The information contained within, does not constitute and should not be construed as an offer of, invitation or proposal to make an offer for, recommendation to apply for or an opinion or guidance on a financial product, service and/or strategy. Any distribution, by whatever means, of the information within and related material to persons other than those referred to above is strictly prohibited. In the United Arab Emirates this material is only intended for -natural Qualified Investor as defined by the Securities and Commodities Authority (SCA) Chairman Decision No. 3/R.M. of 2017 concerning Promoting and Introducing Regulations. Neither the DFSA or any other authority or regulator located in the GCC or MENA region has approved this information. In the State of Kuwait, those who meet the description of a Professional Client as defined under the Kuwait Capital Markets Law and its Executive Bylaws. In the Sultanate of Oman, to sophisticated institutions who have experience in investing in local and international securities, are financially solvent and have knowledge of the risks associated with investing in securities. In Qatar, for distribution with pre-selected institutional investors or high net worth investors. In the Kingdom of Bahrain, to Central Bank of Bahrain (CBB) Category 1 or Category 2 licensed investment firms, CBB licensed banks or those who would meet the description of an Expert Investor or Accredited Investors as defined in the CBB Rulebook. The information contained in this document, does not constitute and should not be construed as an offer of, invitation, inducement or proposal to make an offer for, recommendation to apply for or an opinion or guidance on a financial product, service and/or strategy. In Singapore, this is issued by BlackRock (Singapore) Limited (Co. registration no. 200010143N). This advertisement or publication has not been reviewed by the Monetary Authority of Singapore. In Hong Kong, this material is issued by BlackRock Asset Management North Asia Limited and has not been reviewed by the Securities and Futures Commission of Hong Kong. In South Korea, this material is for distribution to the Qualified Professional Investors (as defined in the Financial Investment Services and Capital Market Act and its sub-regulations). In Taiwan, independently operated by BlackRock Investment Management (Taiwan) Limited. Address: 28F., No. 100, Songren Rd., Xinyi Dist., Taipei City 110, Taiwan. Tel: (02)23261600. In Japan, this is issued by BlackRock Japan. Co., Ltd. (Financial Instruments Business Operator: The Kanto Regional Financial Bureau. License No375, Association Memberships: Japan Investment Advisers Association, the Investment Trusts Association, Japan, Japan Securities Dealers Association, Type II Financial Instruments Firms Association.) For Professional Investors only (Professional Investor is defined in Financial Instruments and Exchange Act). In Australia, issued by BlackRock Investment Management (Australia) Limited ABN 13 006 165 975 AFSL 230 523 (BIMAL). The material provides general information only and does not take into account your individual objectives, financial situation, needs or circumstances. In China, this material may not be distributed to individuals resident in the People’s Republic of China (“PRC”, for such purposes, excluding Hong Kong, Macau and Taiwan) or entities registered in the PRC unless such parties have received all the required PRC government approvals to participate in any investment or receive any investment advisory or investment management services. For Other APAC Countries, this material is issued for Institutional Investors only (or professional/sophisticated /qualified investors, as such term may apply in local jurisdictions). In Latin America, for institutional investors and financial intermediaries only (not for public distribution). No securities regulator within Latin America has confirmed the accuracy of any information contained herein. The provision of investment management and investment advisory services is a regulated activity in Mexico thus is subject to strict rules. For more information on the Investment Advisory Services offered by BlackRock Mexico please refer to the Investment Services Guide available at www.blackrock.com/mx
Not FDIC Insured | May Lose Value | No Bank Guarantee
© 2022 BlackRock, Inc. All Rights Reserved. BLACKROCK, iSHARES and ALADDIN are trademarks of BlackRock, Inc. or its subsidiaries in the United States and elsewhere. All other trademarks are those of their respective owners.
BIIM1221U/M-1972635