Traders work on the floor of the New York Stock Exchange (NYSE) in New York City, March 27, 2023.
Brendan McDermid | Reuters
According to wealth management giant BlackRock and others on Wall Street, investors are too confident that the Federal Reserve will cut interest rates this year and could pay the price later.
Tuesday morning’s market prices indicated that the Fed will leave its benchmark interest rate at current levels and then start cutting it as early as July, according to CME Group calculations. Those cuts could be as much as a full percentage point by the end of the year, the company’s FedWatch gauge shows.
This is despite several public statements from central bank officials, who in their unofficial “dot plot” forecast last week indicated that they likely see another quarter-point hike and then no cuts until at least late 2023.
The expectation of cuts would be consistent with a recession and a accompanying fall in inflation, assumptions that Wall Street strategists find dubious.
“We don’t see any rate cuts this year – that’s the old playbook if central banks rushed to bail out the economy when the recession hit,” BlackRock said in its weekly note to clients. “Now they’re causing the recession to fight stubborn inflation, and that makes rate cuts unlikely in our view.”
The impact on the investment is ominous: BlackRock, which manages around $10 trillion in client funds, says it is underweight stocks in developed markets like the US. Instead, it advises clients to focus on investments such as fixed income securities indexed to inflation and short-dated government bonds.
The resilience in stocks, the company said, comes largely as markets still cling to hope that the Fed is easing after a year of tightening, which pushed the federal funds rate up 4.75 percentage points.
“We believe the Fed could only implement the rate cuts markets are pricing in if a more severe credit crunch hits and causes an even deeper recession than we expect,” BlackRock strategists wrote.
A slowing economy with high inflation
Forecasts released by the Fed following its latest rate hike last Wednesday point to a mild recession later this year.
The median expectation for gross domestic product growth for the year as a whole is 0.4%. Given that first-quarter earnings came in at 3.2%, according to an Atlanta Fed gauge, the math would require at least negative growth the rest of the way to match the 0.4% estimate.
At the same time, officials are estimating an unemployment rate of 4.5% by the end of the year, from the current 3.6%. To get there, more than 571,000 jobs would have to be lost, according to an Atlanta Fed calculator.
While that would be a challenge, the Fed is likely to prioritize its inflation fight, especially if the data continues to point to elevated prices, wrote Citigroup economist Andrew Hollenhorst.
“Concerns about financial stability are likely to remain at least somewhat heightened over the coming months. That means a more cautious Fed and markets are pricing in a higher likelihood of more dovish policy outcomes,” Hollenhorst said. “But unless the risks in the financial sector materialize, the focus will gradually shift back to inflation.”
Analysts at Bank of America note the paradox that investors are simultaneously pricing in a Fed that will ease policy to combat an economic slowdown while betting shares will continue to rise.
“Major US stock indexes appear to be looking beyond the type of shock or economic slowdown that would prompt the Fed to cut rates, yet are trading in anticipation of an (eventually) lower discount factor,” BofA said. “This is despite two important facts: (i) recessions are reliably negative for stocks throughout history and are not discounted in advance, and (ii) the FOMC forecasts and points do not imply rate cuts, even if we have a mild recession this year receive.”
Like BlackRock, Bank of America advises clients to bet against US stocks and instead focus on strategies that pay off when the market falls.
Comments are closed.