Resetting Rate Expectations

Jul. 17, 2017 10:49 AM ETTBT, TLT, TMV, IEF, SHY, TBF, EDV, TMF, PST, TTT, ZROZ, VGLT, TLH, IEI, BIL, TYO, UBT, UST, DLBS, PLW, DTYS, SPTL, VGSH, SHV, VGIT, GOVT, SCHO, TBX, SCHR, FTT, SPTI, GSY, TYD, DTYL, EGF, VUSTX, DLBL-OLD, TYBS, SPTS, DTUS, TUZ, DTUL, DFVL, TAPR, TBZ, DFVS, TYNS, RISE, FIBR, GBIL, HYDD, EUFN, EUFL, EUFS, SPY, QQQ, DIA, SH, IWM, TZA, SSO, TNA, VOO, SDS, IVV, SPXU, TQQQ, UPRO, PSQ, SPXL, UWM, RSP, SPXS, SQQQ, QID, DOG, QLD, CRF, DXD, UDOW, RWL-OLD, SDOW, VFINX, URTY, EPS, TWM, SCHX, VV, RWM, DDM, SRTY, VTWO, QQEW, QQQE, FEX, ILCB, SPLX, EEH, EQL, SFLA-OLD, SPSM, QQXT, SPUU, IWL, FWDD, SYE, SBUS, SMLL, SPXE, PPLC, PPSC, UDPIX, JHML, OTPIX, RYARX, SPXN, USSD, HUSV, RYRSX, SCAP, SPDN, SPXT, SPXV, USWD, VGK, HEDJ, FEZ, IEV, EPV, EZU, SPEU, EURL, DBEU, EEA, FEP, HEZU, UPV, IEUR, FEEU, ADRU, FIEU, DBEZ, FEUZ, CHPT, HFEZ, HFXE, DEZU, FIEE, GSEU, HGEU, PTEU, RFEU

Richard Turnill

1.02K Followers

Key points

Central banks are retreating from super accommodative policies. We prefer stocks over bonds amid moderately rising rates.
Markets priced in more gradual U.S. policy tightening after comments by the Federal Reserve chair and soft inflation data.
The European Central Bank meets this week. Markets are also looking ahead to President Mario Draghi's August speech.

Central banks increasingly are moving away from excessively easy monetary policy. Yields paused after recent gains last week, partly on soft inflation data. Yet we see them rising gradually, reinforcing the case for stocks over bonds.

Difference between five- and two-year government bond yields, 2017

Sources: BlackRock Investment Institute, with data from Thomson Reuters, July 2017.
Note: The lines show the difference between benchmark nominal five- and two-year government bond yields for each country in percentage points. European Central Bank comments refers to Mario Draghi's comments at the central bank's annual policy forum on June 27 in Portugal.

Monetary tightening expectations shifted upward globally in June after markets interpreted ECB remarks as hawkish. This was reflected in a sharp rise in the gap between five- and two-year yields - a key gauge of monetary policy expectations. Germany led the move higher, as seen in the chart above.

The beginning of the end of ultra-easy monetary policy

The major catalyst for the upward shift: ECB President Mario Draghi's June comments on the need to normalize policy. Draghi said "a constant policy stance will become more accommodative," as easy financial conditions accelerate economic activity. We see inflation in the eurozone eventually picking up amid ongoing monetary support, a sustained global economic expansion and an improving eurozone outlook. Accordingly, we see the ECB announcing in September that it will start scaling down its asset purchases beginning in 2018. We expect prudence and patience to guide the bank's process for withdrawing monetary stimulus.

Elsewhere, the Fed appears committed to normalizing interest rates further and initiating its balance sheet reduction this year. Fed Chair Janet Yellen appeared to reinforce this stance last week in Congressional testimony that we view as consistent with past communications. Also, the Bank of Canada last week raised rates for the first time since 2010 and markets expect an October rate hike.

We believe gradual monetary policy normalization and sustained global economic expansion point to moderately higher global bond yields. This supports our preference for stocks over bonds and our favoring of the momentum and value style factors. A risk to our view: global policy normalization disrupts bond markets more than we expect and significantly higher bond yields undermine economic progress and equity valuations. We view this as unlikely.

Stocks rallied, led by emerging markets, after markets interpreted Fed Chair Yellen's Congressional testimony as a sign normalization will be gradual.
U.S. Treasury yields fell and the U.S. dollar weakened after headline U.S. consumer inflation and retail sales missed expectations. Core inflation remained soft. Chinese inflation showed stabilization.
Major U.S. banks beat earnings and revenue expectations, which had been lowered on weak trading activity. President Trump tapped former Treasury official Randal K. Quarles to be the Fed's top banking regulator.

Global snapshot

Weekly and 12-month performance of selected assets

Equities	Week	YTD	12 Months	Div. Yield
U.S. Large Caps	1.4%	9.8%	13.7%	2.0%
U.S. Small Caps	0.9%	6.0%	20.5%	1.2%
Non-U.S. World	2.9%	16.9%	19.6%	3.0%
Non-U.S. Developed	2.4%	16.0%	19.1%	3.2%
Japan	2.3%	10.5%	16.6%	2.1%
Emerging	4.6%	23.1%	23.7%	2.5%
Asia ex-Japan	3.7%	26.5%	26.1%	2.4%

Bonds	Week	YTD	12 Months	Yield
U.S. Treasuries	0.4%	1.8%	-2.3%	2.3%
U.S. TIPS	0.6%	0.9%	-1.1%	2.3%
U.S. Investment Grade	0.6%	4.0%	1.4%	3.2%
U.S. High Yield	0.5%	5.2%	10.0%	5.6%
U.S. Municipals	0.3%	3.7%	-0.3%	2.3%
Non-U.S. Developed	1.2%	6.3%	-3.2%	0.9%
Emerging Market $ Bonds	1.1%	6.4%	4.0%	5.4%

Commodities	Week	YTD	12 Months	Level
Brent Crude Oil	4.7%	-13.9%	3.3%	$48.9
Gold	1.3%	7.1%	-8.0%	$1,228.7
Copper	1.7%	7.1%	19.9%	$5,926.0

Currencies	Week	YTD	12 Months	Level
Euro/USD	0.6%	9.1%	3.1%	1.15
USD/Yen	-1.2%	-3.8%	6.8%	112.53
Pound/USD	1.6%	6.1%	-1.8%	1.31

Source: Bloomberg. As of July 14, 2017.
Notes: Weekly data through Friday. Equity and bond performance are measured in total index returns in U.S. dollars. U.S. large caps are represented by the S&P 500 Index; U.S. small caps are represented by the Russell 2000 Index; Non-U.S. world equity by the MSCI ACWI ex U.S.; non-U.S. developed equity by the MSCI EAFE Index; Japan, Emerging and Asia ex-Japan by their respective MSCI Indexes; U.S. Treasuries by the Bloomberg Barclays U.S. Treasury Index; U.S. TIPS by the U.S. Treasury Inflation Notes Total Return Index; U.S. investment grade by the Bloomberg Barclays U.S. Corporate Index; U.S. high yield by the Bloomberg Barclays U.S. Corporate High Yield 2% Issuer Capped Index; U.S. municipals by the Bloomberg Barclays Municipal Bond Index; non-U.S. developed bonds by the Bloomberg Barclays Global Aggregate ex USD; and emerging market $ bonds by the JP Morgan EMBI Global Diversified Index. Brent crude oil prices are in U.S. dollars per barrel, gold prices are in U.S. dollar per troy ounce and copper prices are in U.S. dollar per metric ton. The Euro/USD level is represented by U.S. dollar per euro, USD/JPY by yen per U.S. dollar and Pound/USD by U.S. dollar per pound. Index performance is shown for illustrative purposes only. It is not possible to invest directly in an index. Past performance is not indicative of future results.

Asset class views

Views from a U.S. dollar perspective over a three-month horizon

This post originally appeared on the BlackRock Blog.

This article was written by

Richard Turnill

1.02K Followers

Richard Turnill, Managing Director, is Global Chief Investment Strategist for BlackRock, leading the Investment Strategy Function within the BlackRock Investment Institute (BII). He is responsible for ensuring we create, coordinate and communicate value added market and investment insights and deliver them consistently to our clients and client facing professionals. Prior to his current role he was Chief Investment Strategist for the Alpha Strategies Group, responsible for developing strategic plans around the Alpha Strategies product range and the positioning of Alpha Strategies products both internally and externally. He has also served as Head of the Global Equity team within the Fundamental Active Equity division of BlackRock's Portfolio Management Group. He was responsible for leading the team which manages large cap global equity portfolios. Mr. Turnill's service with the firm dates back to 1996, including his years with Merrill Lynch Investment Managers (MLIM), which merged with BlackRock in 2006. At MLIM, he led the global equity team and was responsible for overseeing all aspects of the investment process. Earlier, Mr. Turnill was a group economist in MLIM's Central Strategy Group, head of MLIM's asset allocation and economics team, and was the Chief Investment Officer for the Merrill Lynch Global Private Client discretionary business in EMEA Pacific. Prior to joining MLIM in 1996, Mr. Turnill worked in the international division of the Bank of England as an economic advisor and the global economics team of Paribas Capital Markets in London. Mr. Turnill earned an MA degree in economics from Cambridge University in 1991.

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