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Weekly
commentary
September 19, 2022

Sticking with reduced risk taking Wei Li

Global Chief Investment
• The new regime of macro volatility is playing out with weaker growth, persistent
Strategist – BlackRock
inflation and volatile markets. We stick with our dialed-down risk stance. Investment Institute
• U.S. stocks slumped and yields surged on a renewed rise in core inflation. We’ve
argued inflation will be persistent and see the Fed hiking through year-end. Alex Brazier
Deputy Head –
• Central banks are the main attraction this week. The Fed and the Bank of BlackRock Investment
England are set to hike rates again. We see the Fed hiking 0.75% a third time. Institute

The new regime of macro volatility is playing out. Business activity is slumping and
Scott Thiel
higher inflation persists. Central banks are responding with aggressive rate hikes
Chief Fixed Income
without fully acknowledging the growth damage required. Expected policy rates Strategist – BlackRock
have jumped further since we downgraded developed market (DM) stocks in July – Investment Institute
and recession risks still aren’t factored in. We reaffirm our reduced risk taking
stance in our tactical views and favor credit over stocks.
Beata Harasim
Senior Investment Strategist
Weak growth, higher rates: a tough combo – BlackRock Investment
Manufacturing PMIs and policy rate pricing, 2022 Institute

Manufacturing PMI Market pricing of future policy rates

60 4%

58 3%

56
2%
Rate
Index

54
1%
52
0%
50
n U.S. n Euro area
48 -1%
Jan 22 Apr 22 Jul 22 Jan 22 Apr 22 Jul 22

Sources: BlackRock Investment Institute, with data from S&P and Refinitiv Datastream, September 2022. Notes: the left
chart shows S&P Manufacturing Purchasing Managers’ Indexes - a value below 50 indicates contracting activity. The
right chart shows the pricing of expected central bank policy rates via forward overnight index swaps. The rate shown is Visit BlackRock Investment
the one-year OIS rate expected starting one year from now.
Institute for insights on the
Business activity is already stalling in the U.S. and Europe, as business surveys global economy, markets
show (left chart). Yet the Federal Reserve and the European Central Bank (ECB) and geopolitics.
are expected to hike rates aggressively with a singular focus on fighting inflation
(right chart). Last week’s U.S. CPI report confirmed why we don’t see a soft
landing for the economy: inflation is proving sticky as we expected, and central
banks are following a whatever-it-takes approach to inflation. This suggests they
will overreact to upside inflation surprises but not necessarily respond to
downside surprises. The upshot? We expect a policy overtightening that causes
recessions. Our whole portfolio approach prompts us to reaffirm our tactical views
taking reduced risk. We favor credit given our view that a major default cycle is
unlikely and are underweight DM equities given the recession hit we see ahead.

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Our investment views had already been based on a mild recession in the U.S. and a deeper one in Europe given the energy
crunch – but we don’t think risk assets have come to terms with the combination of deteriorating activity and central banks
pushing up rates more quickly. These developments prompt us to stick with our tactical positioning.

Our relative preference for high quality credit over equities still holds because of one big aspect: valuation. Higher spread s
and government bond yields push up expected returns. And strong balance sheets imply investment grade credit could
weather a recession better than stocks. We like investment grade credit, especially with short maturities, over high yield. This
reflects our preference to be up in quality amid a worsening macro backdrop.

We’re underweight most DM equities for now. We haven’t bought the dips all year. The combination of an imminent recession
and higher rates is still not fully reflected in equity valuations, in our view. If and when both of these are factored in – we
would tilt back to neutral on stocks and start to consider signposts to turn more positive.

We are underweight U.S. Treasuries. Overall, we see long-term yields moving higher as investors demand greater term
premium – the extra return that investors demand to compensate them for the risk of holding long-term bonds amid
persistent inflation and high debt loads. That’s partly why we favor inflation-linked bonds - we expect inflation to persist and
this isn’t reflected in current pricing. We’ve also started to prefer short-term over long-term government bonds. We’re neutral
European government bonds, but we think the market pricing of the ECB is unrealistically hawkish given the deteriorating
growth outlook on the back of the energy crisis.

Our bottom line: The new regime of macro volatility is taking root with weaker growth, persistent inflation and volatile
markets. Our whole portfolio approach prompts us to stick with our tactical views especially with the macro deterioration
since our last update. We like credit over equities on valuations. High quality credit can also weather a recession better th an
stocks, we think. Persistent inflation keeps us away from longer-term nominal government bonds and makes inflation-linked
bonds more attractive. Shorter-term government bonds are looking better because market pricing of policy rates looks too
hawkish to us and recession risks are underappreciated. We think economic damage from rate hikes, and the energy crunch
in Europe, will eventually lead central banks to stop hiking, but not anytime soon given persistently high core inflation.

Market backdrop
U.S. equities slumped and Treasury yields pushed near this year’s highs after data showing a renewed rise in U.S. core
inflation in August, suggesting core higher inflation will persist. That prompted the market to price in a third-straight 0.75%
rate hike by the Fed next week and more big hikes for the rest of this year. We see the Fed hiking rates through year-end. Yet
we doubt the Fed will acknowledge the recession needed to bring inflation back to its 2% target in its projections next week.

Assets in review
Selected asset performance, 2022 year-to-date return and range

Brent crude
U.S. dollar index
Gold
Eu ropean equities
U.S. 10-year Treasury
Global high yield
German 10-year Bund
Global corporate IG
Hard-currency EM debt
U.S. equities 2022 range
EM equities Year-to-date
Italian 10-year BTP

-30% -20% -10% 0% 10% 20% 30% 40% 50% 60% 70%
Total return

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 Sept. 16, 2022. 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 U.S. dollars, and
the rest in local currencies. Indexes or prices used are: spot Brent crude, ICE U.S. Dollar Index (DXY), spot gold, MSCI Emerging Markets Index, MSCI Europe Index, Refinitiv Datastream 10-
year benchmark government bond index (U.S., Germany and Italy), Bank of America Merrill Lynch Global High Yield Index, J.P. Morgan EMBI Index, Bank of America Merrill Lynch Global
Broad Corporate Index and MSCI USA Index.

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Macro take An alternative path for growth

Illustrative GDP scenarios, 2017-2025
Central banks appear set on doing whatever it takes to get
inflation back down to 2% as quickly as possible and avoid
any risk of inflation expectations de-anchoring. Yet – as
Jean and Alex explain in our latest Macro Take – they are
mostly silent about the cost of that for growth. We think it
would require a deep and painful recession (see the pink line

Level of real GDP

on the chart). But there’s an alternative.
Central banks could reduce the hit to growth by taking n Real GDP
n Pre-pandemic trend
longer to bring inflation back to target (green line). That n Path with higher inflation
would give the economy a chance to rebalance as n Path to bring inflation
production capacity slowly recovers (yellow dotted line). The down quickly
cost of that choice is inflation staying somewhat higher for n Production capacity
longer. But if inflation expectations remain anchored as they
are now, that could overall be a better outcome for society. 2017 2019 2021 2023 2025

This is not an easy economic environment to navigate. The F or ward-looking estimates may not come to pass.Source: BlackRock Investment Institute, Sept.
question is - which is the least bad outcome? It’s time for a 2022. Notes: The chart shows a stylized path for demand in a hypothetical economy, measured by
public debate. Read the full blog and head over to Twitter to real GDP (in purple), and a projection of pre-Covid trend activity (in orange). The yellow line shows
cast your vote on what’s the right balance between growth how much production capacity may have fallen since Covid. The pink line shows a hypothetical
and inflation. projection of GDP consistent with bringing inflation down to 2% by the end of 2024, while the
green line shows an alternative path in which inflation remains above 2% over the same period.

Investment themes
1 Bracing for volatility
• The Great Moderation, a long period of steady growth and low inflation, has ended in our view. We see macro and
market volatility reverberating through the new regime. What changed? Production constraints triggered by the
pandemic and the war in Ukraine are pressuring the economy and inflation. We see this persisting amid powerful
structural trends like global fragmentation and sectoral shakeouts tied to the net-zero transition.
• Unprecedented leverage gives policymakers less maneuvering room, in our view. And the politicization of everything
makes simple solutions elusive when they’re needed the most, we think. This leads to bad outcomes.
• We expect higher risk premia for both equities and bonds – so investment decisions and horizons must adapt more
quickly. Traditional portfolios, hedges and risk models won’t work anymore, we think.
• In the U.S., we expect volatile growth and persistent inflation. The upside risk is that production capacity normalizes
faster. The downside is that the Fed fails to change course next year and slams demand down to meet low capacity.
• In Europe, we see recession as likely even absent big rate hikes as broad economic stress from an energy crisis bites.
• Investment implication: Be nimble. We’re tactically overweight investment grade credit on attractive valuations.

2 Living with inflation

• We are in a new world shaped by supply. Major spending shifts and production constraints are driving inflation.
• Constraints are rooted in the pandemic and have been exacerbated by the war in Ukraine and China’s lockdowns.
• The Fed increased rates by another 0.75% in July and reaffirmed projections of more rate rises with the aim to rein
in inflation. At Jackson Hole, Fed Chair Jerome Powell emphasized that the inflation objective is “unconditional.” We
think this leaves the Fed with no room to back off its hiking intention – and now that can only happen after the Fed is
surprised by the growth damage rate hikes will cause.
• The Bank of England raised rates to 1.75% in August. It also acknowledged the growth -inflation trade-off. It now
sees a protracted recession through 2023, partly due to the energy shock.
• The ECB announced a record 0.75% rate hike in September and cut its growth forecasts. The ECB’s forecasts show it
is still underappreciating the energy crunch’s hit to growth, in our view. We expect the ECB to keep raising rates
through this year but then stop once it sees the scale of economic damage caused by the energy crisis and hikes.
• Investment implication: We are tactically underweight most DM equities after having further trimmed risk.

3 Positioning for net zero

• 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 net-zero journey is not just a 2050 story; it's a now story.
• We see a global drive for more energy security accelerating the transition in the medium term, especially in Europe.
• We also don’t think the markets have fully priced in the transition yet. Over time, markets are likely to value assets of
companies better prepared for the transition more highly relative to others, in our view.
• We think investors can get exposure to the transition by investing not only in “already green” companies but also in
carbon intensive companies with credible transition plans or that supply materials critical to the transition.
• We like sectors with clear transition plans. Over a strategic horizon, we like sectors that stand to benefit more from
the transition, such as tech and healthcare, because of their relatively low carbon emissions.
• Investment implication: Time horizon is key. We see tactical opportunities in selected energy stocks.

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Week ahead
Sept. 21 Fed policy decision Sept. 23 Global flash PMIs

Bank of England and Bank of

Sept. 22 Japan policy decisions

The Fed seems determined to get inflation down to 2% without recognizing the extent of the contraction needed to do so, in our view. The
upside surprise in the August U.S. CPI confirms why we expect the Fed to hike rates by 0.75% for a third straight time. The BoE has
recognized the inflation-growth trade-off it faces and still seems determined to trigger a recession to fight inflation – especially after the
UK fiscal response to the energy shock.

Directional views
Strategic (long-term) and tactical (6-12 month) views on broad asset classes, September 2022

Underweight Neutral Overweight n Previous view

Asset Strategic view Tactical view

We are overweight equities in our strategic views. A higher risk

premium and worsening macro backdrop lowers our expected
equity returns. But we expect central banks to ultimately live
Equities with some inflation and look through the near-term risks.
Tactically, we’re underweight DM stocks as central banks look
set to overtighten policy – we see activity stalling. Rising input
costs also pose a risk to elevated corporate profit margins.

Strategically, we are overweight publicly traded credit – from

high yield to global investment grade. Higher spreads and
government bond yields push up expected returns, and we
think default risk is contained. Additionally, income potential is
Credit
attractive. Tactically, we’re overweight investment grade but
neutral high yield. We prefer to be up in quality. We overweight
local-currency EM debt on attractive valuations. A large risk
premium compensates investors for inflation risk, in our view.

A modest underweight in our strategic view on government

bonds reflects a big spread: max underweight nominal, max
overweight inflation-linked and an underweight on Chinese
bonds. We see nominal yields in five year’s time significantly
Govt
higher than current levels. That repricing is a valuation drag on
bonds
expected returns. We also think markets are underappreciating
the persistence of high inflation. Tactically, we are also
underweight as we see long-term yields going higher – even as
yields have surged in 2022.

We’re underweight private growth assets and neutral on private

credit, from a starting allocation that is much larger than what
most qualified investors hold. Private assets are not immune to
Private higher macro and market volatility or higher rates, and public
markets market selloffs have reduced their relative appeal. Private
allocations are long-term commitments, however, and we see
opportunities as assets reprice over time. Private markets are a
complex asset class not suitable for all investors.
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
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.

▲ Overweight — Neutral ▼ Underweight

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Granular views
Six- to 12-month tactical views on selected assets vs. broad global asset classes by level of conviction, September 2022

Underweight Neutral Overweight n Previous view

Asset View Commentary

We are underweight DM stocks on a worsening macro picture and risks to

corporate profit margins from higher costs. Central banks appear set on reining
Developed markets
in inflation by crushing growth – increasing the risk of the post-Covid restart
being derailed.

We are underweight U.S. equities. The Fed intends to raise rates into restrictive
United States
territory. The year-to-date selloff partly reflects this. Yet valuations have not
come down enough to reflect weaker earnings.

We are underweight European equities as the fresh energy price shock in the
Europe
aftermath of the tragic war in Ukraine puts the region at risk of stagflation.
Equities

We are underweight UK equities following their strong performance versus

UK
other DM markets thanks to energy sector exposure.

We are neutral Japan stocks. We like still-easy monetary policy and increasing
Japan
dividend payouts. Slowing global growth is a risk.

We are neutral Chinese equities. Activity is restarting, but we see 2022 growth
China below official targets. Geopolitical concerns around China’s ties to Russia
warrant higher risk premia, we think.

We are neutral EM equities on the back of slowing global growth. Within the
Emerging markets
asset classes, we lean toward commodity exporters over importers.

We are neutral Asia ex-Japan equities. China’s near-term cyclical rebound is a

Asia ex-Japan
positive yet we don’t see valuations compelling enough to turn overweight.

We are underweight U.S. Treasuries even with the yield surge. We see long-term
U.S. Treasuries yields moving up further as investors demand a greater term premium. We prefer
short-maturity bonds instead and expect a steepening of the yield curve.

Global inflation- We are overweight global inflation-linked bonds and prefer Europe. Markets are
linked bonds underappreciating the inflationary pressures from the energy shock, we think.

European We are neutral European government bonds. We think market pricing of euro
government bonds area rate hikes is too hawkish.

We are overweight UK gilts. Gilts are our preferred nominal government bonds.
UK gilts We believe market pricing of the Bank of England’s rate hikes is unrealistically
hawkish in light of deteriorating growth.

China government We are neutral Chinese government bonds as policymakers have been slow to
Fixed Income

bonds loosen policy to offset the slowdown, and they are less attractive than DM bonds.

Global investment We are overweight investment grade credit. High quality corporates’ strong
grade balance sheets imply IG credit could weather weaker growth better than stocks.

We are neutral high yield. We prefer up-in-quality credit exposures amid a

Global high yield
worsening macro backdrop. We think parts of high yield offer attractive income.

Emerging market – We are neutral hard-currency EM debt. We expect it to gain support from higher
hard currency commodities prices but remain vulnerable to rising U.S. yields.

We are modestly overweight local-currency EM debt on attractive valuations and

Emerging market –
potential income. Higher yields already reflect EM monetary policy tightening, in
local currency
our view, and offer compensation for inflation risk.

We are neutral Asia fixed income amid a worsening macro outlook. We don’t find
Asia fixed income
valuations compelling enough yet to turn more positive on the asset class.

P a st 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
▲ Overweight — ofNeutral
the market environment ▼ atUnderweight
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.
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BlackRock Investment Institute

The BlackRock Investment Institute (BII) leverages the firm’s expertise and generates proprietary research to provide
insights on the global economy, markets, geopolitics and long-term asset allocation – all to help our clients and portfolio
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