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Asset manager BlackRock has said 2023 will require a new investment playbook, backing banks and energy sectors to do well, while slapping ‘underweights’ on longer-term European government bonds and emerging market local currency debt.

The BlackRock Investment Institute (BII) said in its 2023 global outlook that while the case for investment credit had brightened and short-term government debt yields looked attractive, the pressures of higher interest rates would weigh on longer-term sovereign bonds.

“The macro damage we expect for next year is yet to be fully reflected in market pricing,” said Wei Li, global chief investment strategist at the BII.

BlackRock expects global central banks to over-tighten financial conditions in their fight against stubbornly high inflation to the point of causing a recession next year.

It said it therefore maintained a tactical underweight on developed market equities, while recommending investors to gravitate towards high-quality corporate debt and short-dated U.S. Treasury bonds, given the returns they offer after this year’s rapid increase in interest rates.

“We are going to see inflation falling ... but at the same time we don’t think we’re going to be settling back to the 2% world we’ve been accustomed to, at least not anytime soon,” BII head Jean Boivin said at a media briefing in New York.

“We don’t think the inflation outcome we’ll end up living with, which is going to be more like 3% than 2%, is reflected in markets at this juncture,” he said.

Sustained higher inflation could mean central banks will unlikely cut interest rates rapidly to support contracting economies, BlackRock said, so the old playbook of adding exposure to long-term and safe government bonds in a recessionary environment may not work next year.

“Policy rates may stay higher for longer than the market is expecting ... As a result, we remain underweight long term government bonds in tactical and strategic portfolios,” BII said in its outlook report.

As part of that stance, it has moved underweight on longer term European government debt as well as UK Gilts. Gilts have seen a strong rebound in recent weeks after been thrown into turmoil by the unfunded tax plans of former UK leader Liz Truss and her finance minister Kwasi Kwarteng.

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