- The U.S. stock market expects the Fed to keep its benchmark interest rate at current levels and then begin cutting it in July.
- Forecasts of rate cuts are in line are based on an expected recession and falling inflation.
- But strategists at the asset management giant are not so sure that investors’ perceptions are correct.
U.S. investment management firm Black Rock, warned that investors could be making a serious mistake by relying too much on a possible interest rate cut by the Federal Reserve.
In the view of the mega asset management firm and other Wall Street analysts, investors could pay a heavy price if their forecasts turn out to be uncertain this year and the Fed holds off on scheduled increases.
This week, stock market movements indicate that the U.S. central bank will keep interest rates at current levels and then begin to slow the pace of increases starting in July, CME Group noted.
Cuts are expected to reach one percentage point by the end of the year, according to the company’s FedWatch indicator. In their statements, Fed policymakers have signaled that further increases are coming.
Last week during the unofficial “dot plot” forecast show, officials signaled that there would likely be a further quarter-percentage-point increase. After that there would be no further cuts this year.
“We see no rate cuts this year”
With this policy, the Fed hopes to cool the economy which would translate into an expected recession to bring down the high inflation rates recorded since 2022. If inflation falls, as they assume at the Fed, they will start cutting rates again. But Wall Street strategists are not so sure.
“We don’t see rate cuts this year, that’s the old playbook when central banks rush to rescue the economy when recession hits,” BlackRock strategists noted in a weekly note to clients according to CNBC.
“They are now causing the recession to fight sticky inflation and that makes rate cuts unlikely, in our view,” they added.
If things don’t turn out as investors anticipate, this policy will have a very negative impact on markets. BlackRock alone manages about $10 trillion of its clients’ money. The firm says it is underweight in stocks in developed markets such as the US.
But it recommends investors focus on inflation-indexed fixed-income-related investments. It also sees short-duration Treasuries as a favorable option for these times.
Equity resilience
BlackRock believes that the resilience seen in the performance of equities is largely due to the fact that investors are still hopeful that the Federal Reserve will ease its policies.
The Fed’s benchmark rate has been pushed to 4.75 percentage points after a series of sharp increases that began last year.
“We believe the Fed could only achieve the rate cuts discounted by markets if a more severe credit crisis were to occur and cause an even deeper recession than we expect,” BlackRock wrote in its note.
Economy slows but inflation remains high
According to the latest projections of interest rate increases released by the Fed, the U.S. economy is likely to enter a mild recession by the end of 2023, driven by the banking crisis.
The economy’s growth projections put GDP for this year at 0.4%. The Atlanta Fed’s gauge states that the first quarter increase remains at 3.2%. So for there to be 0.4% growth at some point GDP would have to fall back quite a bit.
On the other hand, it is estimated that during 2023 the unemployment rate will reach 4.5%. It currently stands at 3.6%. In order to reach the expected unemployment figure at the end of the year, some 571,000 jobs will have to be lost in the coming months.
Nevertheless, the likelihood of the Fed maintaining its fight against inflation is a given. Especially if price behavior remains high, says Andrew Hollenhorst, an economist at Citigroup.
“Financial stability concerns are likely to remain at least somewhat elevated over the next few months. That means a more cautious Fed and markets pricing in a higher likelihood of more dovish policy outcomes,” Hollenhorst explained.
He added that “to the extent that financial sector risks do not materialize, the focus will gradually return to inflation.”
BofA believes that the Fed will ease policy
Analysts at Bank of America, in addition to observing a paradox among investors, believe that the Fed will ease policy to avoid a further economic slowdown.
BofA strategists are betting that stock prices will continue to rise. “The major U.S. stock indexes appear to be looking past the type of economic shock or slowdown that would cause the Fed to cut rates, yet they are trading with expectations of an (eventually) lower discount factor,” they said.
“This is despite two important facts: (i) recessions are negative for stocks throughout history and are not discounted in advance, and (ii) the FOMC’s projections and points do not imply rate cuts even if we have a mild recession this year,” they forecast.
Bank of America also advises its clients to bet against U.S. stocks. Like BlackRock, they believe investors should focus on investment strategies that pay off when the market dips.
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