Storm clouds are once again hanging over markets around the world in the wake of the collapse of Silicon Valley Bank.
These events follow what BlackRock Investment Institute (BII) chief APAC strategist Ben Powell has described as a historically, “almost unprecedented tightening in rates” across the globe.
“You had, in 2022, the monetary policy lightning, and then there’s that strange moment where you are between the lightning and the thunder, and it felt like coming into this year that that’s where we were. But as we learn at school, monetary policy works with long and variable lags, so the thunder’s coming, you just don’t know exactly when,” he said at a recent roundtable.
“It is coming, and it seems, actually like just in the last few days, maybe we’ve had an example of the kind of thing you would expect to see when you tighten monetary policy fairly dramatically, very quickly. These sorts of things can happen.”
Mr Powell acknowledged that the BII would not have been able to predict the events that have played out in the past few days.
“But I think it’s in line with our broad thinking coming into the year, which is that economic lightning, monetary policy lightning, will create economic thunder and so you don’t know exactly what form the unexpected can take,” he added.
“Having these sorts of things happen, when you raise the cost of money, very dramatically, very fast is quite normal. If you look through history, any kind of hiking of this scale at this pace normally leads to some consequences, not all of which are positive.
“So again, to be clear, of course we didn’t see precisely what’s happened over the last few days playing out, but coming into 2023, our framework, I think, is very much in line with this kind of a risk and frankly we expect to see more of this.”
The BII will be paying close attention to “pricing the damage” in 2023, with the firm second-guessing whether damage has been appropriately priced particularly in developed markets.
“Coming into the year, there’s going to be more damage as more of the lagged impact of the pre-existing monetary policy tightening flows through,” Mr Powell warned.
“That’s going to create a downdraft which will be inconvenient for developed market equities across a couple of dimensions.”
In contrast, Mr Powell suggested that the growth outlook in emerging markets, and in particular China, looks “rather encouraging”.
“In China and other parts of emerging markets, it really is a different situation where growth is strong and if they need to, the lack of any inflation constraints means that, if necessary, there’s room for more policy support through the course of the year,” he stated.
“So that’s just for us a much more encouraging kind of set of stuff circumstances.”
Subsequently, the BII is overweight emerging markets and underweight developed markets.
“We think the damage is underpriced in the West and, if you like, overpriced in the East and the broader emerging market complex,” Mr Powell explained.
Keeping the inflation genie in the bottle
On the topic of interest rates, Mr Powell said that the BII is convinced that central banks globally could overtighten in their battle against inflation.
He highlighted recent testimony from Fed chair Jerome Powell, who said that the US central bank still has a “long way to go” to get inflation back down to target.
“Critically for us, at the BlackRock Investment Institute, the Fed isn’t just okay with a downdraft, they actively want to create a downdraft, because that’s the price they deem worth paying to solve for the pernicious inflation problem,” said BII’s Mr Powell.
“I wouldn’t think of it as a risk. It’s a base case, and that’s why our framework is predicated on that as being the base case, which takes us in a few different directions, but not least a little bit of caution around developed market equities, including US equities.
“We think they are going to stay the course because inflation is the big fear that I think they have front and centre. And sadly, even if that means a downdraft with implications for unemployment and so forth, as I said, I think they feel that’s the price worth paying to try to keep the inflation genie as much in the bottle as is possible.”
Mr Powell noted that central bankers, including the Fed, are facing a “very difficult balancing act” between managing their role as the guarantor of financial stability and fighting inflation.
“We think the Fed is very serious about bringing inflation down and will be highly reluctant to change their tune and the policy settings that they’ve been warming us up for and have been delivering now for coming up to a year,” he stated.
“We, I think, as market observers, shouldn’t get confused that the liquidity provision to maintain financial stability is not the same thing as, sort of, chickening out on the inflation problem. I think they’re going to have to try and do both, and that’s going to be hard, by the way.”
In response to the collapse of Silicon Valley Bank, the Fed has indicated that it is “prepared to address any liquidity pressures that may arise”.
