Global Weekly Commentary: Fiscal boost is not a market risk – yet
Lower for longer?
We see central banks keeping a lid on yield rises for now, yet there is a risk that rising debt levels and inflation eventually threaten the low-rate regime.
Rising inflation expectations have driven up U.S. 10-year Treasury yields but to a lesser degree that in the past, in line with our new nominal theme.
Sentiment data in the U.S. and Europe could shed light on the status of the activity restart amid tightened virus restrictions.
The prospect of another large U.S. fiscal package has fed debates about potential economic overheating. We believe central banks for now have strong incentives to lean against any rapid rise in nominal yields even as inflation rises, supporting our tactically pro-risk stance. Yet rising debt levels may eventually pose risks to the low-rate regime. This is part of why we strategically underweight government debt.
Chart of the week
Estimated U.S. cumulative GDP loss and fiscal support, GFC vs. Covid
Sources: BlackRock Investment Institute and the International Monetary Fund, with data from Haver Analytics, February 2021. Notes: The orange bars show the discretionary fiscal boost following the GFC and Covid shocks. The GFC measure is captured by the change in the cyclically adjusted budget deficit in 2008 and 2009 calculated by the IMF. We use broker estimates of discretionary fiscal measures explicitly introduced in response to Covid for 2020-21. The yellow bars show the cumulative sum of the difference between actual U.S. GDP and where it would have been had it grown at its pre-shock trend rate prior to the Covid-19 shock and the GFC., based on the Refinitiv poll of economists on Jan. 22.
The policy revolution to cushion the Covid shock has driven a record surge in public debt. This is a huge fiscal impulse on its own – but even more so relative to the size and the nature of the shock. We assess that the ultimate cumulative economic loss – what we have long held matters most for financial markets – will be roughly a quarter of that seen after the global financial crisis (GFC). Yet the discretionary fiscal response today is about four times larger, we estimate. See the chart above. Not only is the policy response this time far more overwhelming, but a large part of economic activity will restart on its own once the pandemic is under control, in our view. This is a key difference with the GFC. The objective of the current policy response has been different: it is not to stimulate growth, but to provide a bridge to the post-Covid world. Policymakers, academics, taxpayers and markets have been surprisingly relaxed about the large increase in debt – also a stark contrast to the aftermath of the GFC, when the focus shifted to austerity.
Record-low debt servicing costs help explain more relaxed attitudes to high public debt levels. Public debt in the U.S. is set to reach a record 135% of GDP, according to IMF forecasts. This is twice as high as in the 1990s, but financing costs are only half what they were then. How long will the tolerance of high debt – and the low-yield regime – last? For now we see the new nominal theme in play: a more muted response in nominal government bond yields to rising inflation. Central banks have committed to look through above-target inflation for a while. They may find it politically fraught to raise rates, even if inflation starts to look more concerning. The scars from 2013’s “taper tantrum,” against a backdrop of even higher indebtedness, also create inertia. And if a tantrum were to occur, central banks would quickly be forced to lean against it, in our view. This is why we have conviction the new nominal regime will last for some time – and are tactically pro-risk.
We had stressed in 2019 the importance of clear guardrails around the joint monetary/fiscal policy action. Without them it would be politically challenging to put the fiscal genie back in the bottle and allow central banks to rein in inflation. Over time, this could challenge the demand for government bonds as safe and liquid assets. Investors today pay a premium for holding government bonds for these perceived benefits. We don’t expect central banks to raise rates any time soon. Yet government bonds’ perceived safety could eventually come into question if a narrative took hold that high debt levels and rising inflation make it more risky. Longer-term yields may then start rising as investors demand a greater term premium – the excess yield that compensates them for holding long- over short-term debt. Central banks would initially lean against any yield spikes, in our view, but their ability to sustain such policy would be limited. Issuance of low- or zero-coupon longer term debt – as governments lock in historically low rates – makes bond holders more vulnerable to losses. Example: A one percentage point rise in 30-year German bund yields would spark twice the price loss today than a decade ago, we estimate.
The bottom line: Recent events have strengthened our new nominal thesis: real yields have declined even amid the prospect of almost $3 trillion in additional U.S. fiscal support. This supports our pro-risk stance over a tactical horizon. Whether the low-rate regime lasts will depend not only on monetary policy but on the perceived safety of government bonds. Markets may eventually demand a higher premium for government bonds, even if central banks are more tolerant of higher inflation. This, and reduced ballast properties with yields near lower bounds, is why we strategically underweight the asset class.
© 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 Feb.16, 2021, and are subject to change without notice. Reliance upon information in this material is at the sole discretion of the reader. Investing involves risks. Asset allocation and diversification does not guarantee investment returns and does not eliminate the risk of loss.
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, authorised 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 authorised activities conducted by BlackRock. From 31 December 2020, 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 authorised 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, this document is marketing material. 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, as amended. 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. In the Kingdom of Saudi Arabia this information is only directed to Exempt Persons, Authorized Persons or Investment Institutions, as defined in the relevant implementing regulations issued by the Capital Markets Authority (CMA). 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
© 2021 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.