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Rising inflation usually means rising interest rates, which can hurt both stock and bond markets, but that relationship will no longer hold as tight in the “new investment order,” says BlackRock. 

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In its latest outlook report and webinar, strategists at the world’s largest asset manager said this “new nominal” for interest rates, based on changing central bank monetary policy, supports stronger economic growth and lower yields, which, in turn boosts stock prices and favors inflation-protected bonds.

“Interest rates will respond a lot less to rising inflation than they have done in the past,” said Elga Bartsch, head of macro research at the BlackRock Investment Institute. 

The “policy revolution” — BlackRock’s term for the coordination of policy between monetary and fiscal authorities to address the pandemic’s impact — also includes a significant shift in monetary policy whereby central banks allow inflation to top their targets for a time instead of quashing the increases with rate hikes, explained Bartsch. 

The Federal Reserve has already announced such a policy shift with a new monetary policy framework that lets the U.S. inflation top 2% for a while to help support the job market especially for low- and moderate income workers. The ECB is considering a similar policy approach.

The New Nominal for Interest Rates

This new nominal for interest rates is “underappreciated by markets and will have profound implications for portfolios,” said Jean Boivin, head of BlackRock Investment Institute. The new nominal is especially supportive of risk assets, according to Boivin.

In the medium to long term, beyond 12 months, the new nominal translates into a higher strategic allocation to equities than is normal during a period of rising inflation. In the shorter term, between six and 12 months, BlackRock favors tactical overweight allocations to U.S. equities, including tech health care and small caps, as well as emerging market equities and Asian equities minus Japan. 

It takes a barbell approach to stocks that capture “turbo-charged sectors” like large-cap technology on one side, and cyclical stocks such as small-cap tech, materials, and industrials and emerging market equities on the other, said Mike Pyle, global chief investment strategist at the BlackRock Investment Institute.

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For bonds, the new nominal will constrain real rates, pushing them even further into negative territory, and causing government bonds to act even less as a ballast in portfolios than they traditionally have, said Scott Thiel, chief fixed income strategist at BlackRock Investment Institute. BlackRock is overweight U.S. Treasury inflation-protected securities (TIPS), Asian fixed income bonds and emerging market and global high yield bonds.

The Impact of the Coronavirus Pandemic

BlackRock’s new investment order takes its cue from the coronavirus pandemic — its impact on global economies and global markets — and its differences from past systemic shocks.

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“The traditional business cycle playbook does not apply. This is not a traditional recovery in the same way that the stoppage was different from a traditional recession.”

BlackRock expects the recovery will be more akin to recoveries that follow natural disasters — a “swift economic restart” that reaches full throttle by late 2021, fueled by the distribution of coronavirus vaccines. 

While markets can price in these expected gains rather quickly, the economy will face challenges in the near term — more infections, hospitalizations and deaths — and the European economy may contract in the fourth quarter with the U.S. close behind, according to BlackRock.

The pandemic also accelerated the shift toward a global economy dominated by the U.S. and China, which will remake global supply chains, emphasizing resilience over efficiency. This is not the de-globalization view that some strategists have been forecasting but “a rewiring of globalization,” with two poles of growth that investors should be exposed to, according to BlackRock.

Along with these global changes is the growing importance of sustainable assets and emphasis on environmental, social and governance factors, including those that combat climate change as well as rising economic inequality. 

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“We have reached an inflection point in sustainability,” according to the BlackRock outlook, which refers to “ambitious” net zero targets set by European Union and China, achieving zero emissions by 2050 and 2060, respectively.

The sustainability discussion is no longer about forfeiting performance to attain a sustainable objective. “It is a driver of returns that will play out over years,” Boivin said.

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