- BlackRock strategists suggest the Fed will raise borrowing costs to around 2% this year, but not much further because an overly aggressive path of rate hikes to combat soaring inflation may actually backfire.
- BlackRock believes the Fed will live with inflation because much of that has to do with supply constraints rather than demand.
By now, most investors have braced themselves, at least mentally, for a sharp and aggressive tightening by the U.S. Federal Reserve, which has sent risk assets lower and Treasury yields soaring.
But could the market be wrong?
Possibly, at least according to some strategists at the world’s biggest asset manager BlackRock (-3.85%) who are challenging bets that the Fed will raise rates to around 3% this year.
Instead, BlackRock strategists suggest the Fed will raise borrowing costs to around 2% this year, but not much further because an overly aggressive path of rate hikes to combat soaring inflation may actually backfire.
BlackRock Investment Institute estimates that had the Fed brought inflation last year down to its target 2%, unemployment could have soared to almost 10%, based on the historical relationship between inflation and employment – a scenario that the Fed would not want.
Rather, BlackRock believes the Fed will live with inflation because much of that has to do with supply constraints rather than demand.
And there may be some evidence to support BlackRock’s view.
Last month, U.S. Consumer Price Index data rose at its fastest pace since 1981, but when volatile food and fuel prices were stripped out, so-called “core inflation” was actually slowing, thanks to a moderation in the increase in used vehicle prices.
The Fed’s latest projections for rate hikes also seem to suggest that while the central bank is serious on inflation, it’s not prepared to destroy demand or jobs just to keep prices in check, especially if inflation should ultimately prove to ease later on.
It’s entirely possible then, that markets have swung too far to the opposite side of the curve, with fears of overly aggressive tightening by the Fed triggering a premature selloff in bonds especially near-dated Treasuries, that briefly caused the yield curve to invert earlier this month.
A yield curve inversion is often seen as a warning sign, with near-term borrowing yielding more than long-term borrowing, suggesting that investors believe the Fed won’t just kill inflation, but economic growth as well.
To be fair, the Fed has a lot to take in, and before its rate hike in March, U.S. Federal Reserve Chairman Jerome Powell did emphasize the need for the central bank’s “nimbleness” in adjusting policy to the ever-changing economic circumstances.
Right now, there are growing signs that the risks for recession are increasing, versus the risk of runaway inflation.
As first quarter corporate earnings start coming in this month, investors will have a clearer picture of what the economic outlook looks like, and so far, it’s not been great.
Some of Wall Street’s biggest banks have reported significant falls in revenues from capital-raising activities, a sure sign that businesses are less optimistic of the outlook than a year ago, and denting profits for banks which are generally favored to perform in a strong economy.
Investors are also shifting into consumer essentials and utilities as they build increasingly defensive portfolios, yet another signal that sentiment is leaning towards the downside.
While the Fed isn’t driven by what happens in the market, it does take into consideration a slew of data when it comes to determining policy, and does not obsess about inflation alone, even if that appears to be the biggest challenge at the moment.
It’s entirely possible BlackRock may be right, in which case a strong reversal in languishing sectors of the stock market might be in the offing.
