Investors were not surprised when the Federal Reserve recently increased interest rates to tackle high inflation, which reached 7.9% in the US last month.
The rise of 0.25 percentage points was the first hike for the central bank in four years and the Federal Open Market Committee (FOMC) suggested an additional six increases throughout the year.
However, BlackRock stated in its weekly market commentary that “the Fed is unlikely to deliver on its projected rate path” without greatly damaging economic growth and domestic employment.
Unemployment in the US lowered to 3.8% in February, an improvement from the highs of 6% seen last July when US businesses were recovering from Covid and nationwide lockdowns.
The Fed’s goal of raising rates to 2.8% by the end of next year could put too much pressure on the economy too rapidly and stunt progress made in its revival, according to BlackRock.
Jean Boivin, head of the BlackRock Investment Institute, said: “It would come at too high a cost to growth and employment. We do now see a higher risk of the Fed slamming the brakes on the economy as it may have talked itself into a corner.
“We believe this means the Fed either doesn’t realize its rate path’s cost to employment or – more likely – that it shows its true intention: to live with inflation.”
Many of the main drivers of inflation, such as global supply chain delays, are outside of central banks’ control and will not be affected by changes to monetary policy.
Therefore, BlackRock concluded that central banks will have to accept a certain amount of inflation which some, like the Bank of England (BoE), have already done by signalling that it would pause rate hikes if necessary.
“We believe this means the BoE is willing to live with energy-driven inflation, recognizing that it’s very costly to bring it down,” Boivin said.
Although the Fed “wanted to appear tough” with its hawkish plan to hike rates, BlackRock predicted that it will stop short of its goal and settle for 2% by the end of the year.
Following the Fed’s plan, BlackRock anticipates trouble ahead for long-term government bonds and adjusted allocations in its portfolios two weeks ago accordingly – it is now underweight in nominal government bonds, instead adding to developed market equities.
Boivin said: “We see more pain ahead for long-term government bonds even with the yield jump since the start of the year. We expect investors will demand more compensation for the risk of holding government bonds amid higher inflation.”