Why Fed's policy update supports continued pro-risk stance

The U.S. Federal Reserve’s policy framework, updated through last week’s statement, support a continued pro-risk stance, according to BlackRock’s chief investment strategist for North America.

Kurt Reiman told WP that after the Fed cleared the way to reducing its monthly bond purchases “soon” and signalled that interest rate increases may follow quicker than expected, this remained in line with BlackRock’s own framework.

Inflation, which is running at about 4.2% this year, is proving more persistent than some expected. But despite the central bank’s hawkish tilt, Reiman said it continues to react slower and more methodically to economic data than many are concluding. Yes, the economic reopening is happening but there are still challenges, like supply chain bottlenecks, to overcome.

With the Canadian 10-year bond yield around 1.23% at time of writing, the strategist stressed that intermediate and long-term yields are likely to rise. Reiman said: “The Fed’s policy framework is more moderate and more deliberate, reacting more slowly to the same set of data they're receiving now than they would have in the past. This supports a continued pro-risk stance, which means we favour equities over fixed income.

“Importantly, we think that this economic expansion is more durable because we're not getting this ramp up in momentum in all of the world's economies at the same time as the vaccines are being rolled out [at different speeds]. Right now, the momentum you see is more in places like Europe and Canada, which we think is beneficial to those equity markets, together with the fact those equity markets tend to be cheaper than what you may find in the US. From our point of view, we would be recommending that Canadian investors look beyond the US to other international destinations within the stock market.”

Will, therefore, this expansion have more runway than investors think? Reiman believes that could well be the case but with a very important caveat. Equity outperformance naturally attracts attention and earnings numbers are supported by strong revenue growth, despite some hits to margins because of some higher input costs. He added: “We are in the midst of an economic reopening that seems to have quite a bit of runway left but it's important to say that while the gains from the first half of 2021, 2020 and from 2019 are all very impressive, we need to be mindful that this will be very hard to repeat.”

Speaking after the release of BlackRock’s weekly commentary – titled Debt Ceiling Showdown Redux – in which Reiman wrote about the impact of the recent Canadian election on the financial sector and the dip in stocks amid concerns over distressed Chinese property developer Evergrande, WP asked him whether the Fed’s policy statement would impact the Bank of Canada’s tapering and rate-hike schedule.

He believes that while Governor Tiff Macklem obviously has to be mindful of what the Fed is doing, Canada is operating under a different framework. Reiman said: “That’s important – it’s not like they’re untethered but the reaction function of the Bank of Canada to sustained higher prices will be faster than what you will find in the US with an average inflation targeting framework.

“The differential in short-term interest rates would be in Canada's favour and support an appreciation of the Canadian dollar and the question is, how much of that strength can the economy sustain because it will alter the terms of trade, it will alter export dynamics. So, the Bank of Canada will need to be mindful of that because it then cycles back through into economic growth, and eventually perhaps, disinflationary or even deflationary pressures if it's too extreme.

“Over the next year we're going to be watching this very closely because the Bank of Canada is likely to be moving, as they have on asset purchases, sooner on policy rates than the Fed.”