The recent rise in real yields and moves in the US Treasury market are more indicative of a strong economic restart rather than normal recovery, according to BlackRock’s Investment Institute.
Due to the nature of the Covid-19 shock, the broad-based pent-up demand and different inflation dynamics, the asset management house expects the path out of the Covid-19 shock will be more of a ‘restart’ – rather than a typical business cycle ‘recovery’.
The firm’s strategists said: “The $1.9trn fiscal package and an accelerating vaccination ramp-up in the US magnify these factors and we believe the restart will likely be stronger than markets expect.”
There are three main reasons why BlackRock says this is not a recovery and is more like an economic restart.
The first is due to the nature of the Covid-19 economic shock, which it categorises as more like a natural disaster where economic activity is shut down temporarily and then comes back rapidly.
Indeed, the initial lockdowns in March of 2020 forced a halt in economic activity that triggered a deep plunge in US real GDP.
In the second half of the year when restrictions started to ease, economic activity quickly rebounded and is now “poised to leap forward” as vaccines are rolled out, the team argued.
US real GDP after past recessions and the Covid-19 shock
Source: BlackRock Investment Institute, Refinitiv
“The restart is about turning things back on, not about the rebuilding of confidence that is needed in a typical recovery,” the BlackRock Investment Institute said.
“The restart may be much faster than in typical business cycle recoveries as a result. We believe much activity will restart on its own and won’t need policy stimulus as much as in typical recessions.”
BlackRock expects US real GDP to return to the pre-Covid level by mid-2021, much sooner than its own expectation right after the initial shock.
“We see the new US fiscal package bringing forward the return to pre-Covid trend growth by two to three years – further accelerating the restart,” the firm added.
The second reason the BlackRock team believes there will be a powerful economic restart is because of the broad-based pent-up demand this time around.
“Consumer spending during the Covid shock has been unusual in that spending on services dropped sharply,” it said.
“The stoppage in activity and spending was mainly caused by lockdowns and not income constraints, and – unusually – affected all income groups.
“Household finances are in much better shape today than after the financial crisis, largely thanks to ongoing fiscal policy support.”
It estimates that excess household savings in the US are roughly $1.8trn larger than in the year before the pandemic and that lower-income households have been supported by fiscal stimulus.
In the strategists’ view, this suggests that pent-up demand is more broad-based this time.
The final reason the BlackRock Investment Institute outlined was the very different inflation dynamics today versus in the past.
“A typical recession is caused by a fall in demand,” the team explained. “Demand catches up only slowly to supply in a normal recovery, leading to disinflationary pressure.
“This is less the case today, as the Covid shock was caused by a fall in both demand and supply. Both have to catch up, in our view.”
They believe many companies have used the typical recession playbook by reducing capacity and cutting costs last year and they questioned whether they can ramp up production fast enough as demand surges.
“A failure to do so would lead to additional near-term price pressures,” the team said. “Policy support has been extraordinary.
“We assess that the ultimate cumulative economic loss from the shock – what matters most for markets – will be roughly a quarter of that seen after the global financial crisis in the US.
“Yet the discretionary fiscal response so far is about four times larger and the Federal Reserve has signalled it will be less responsive to rising inflation than in the past.”
Therefore, the BlackRock’s team is anticipating a much stronger post-Covid economic restart than what it would expect in a normal recovery.
The recent rise in real yields and moves in the US Treasury market are as a result justified in its view and is in line with BlackRock’s ‘new nominal’ theme outlined in its 2021 outlook.
This is why over the next six to 12 months, the firm is overweight cyclical assets, US equities, small-cap, private equity and private credit.
It is also overweight emerging market (EM) equities and sees the recent selloff as an opportunity to add to the asset class.
“We still expect EM equities to benefit from a global cyclical upswing, supported by a stable U.S. dollar,” the team said. “The commodity price rally should also help resource-rich EM economies, in our view.”