Markets are getting their Fed call on rate cuts wrong, BlackRock says

• Markets are wrong in thinking the Fed will cut interest rates this year, according to BlackRock. 
• Rate cuts are unlikely while inflation is sticky and the Fed signals bank stress won’t deter it from tightening. 
• The firm doesn’t expect cuts unless a credit crunch leads to a deeper-than-expected recession. 

Investors are betting the Federal Reserve will start chopping down interest rates this year, but that’s a scenario that’s highly unlikely to play out, says BlackRock Investment Institute. 

“We don’t see rate cuts this year – that’s the old playbook when central banks would rush to rescue the economy as recession hit,” Wei Li, global chief investment strategist at BlackRock Investment Institute, wrote in weekly commentary published Monday. 

But the Fed, with its aggressive run of rate hikes over the past year, has been engineering an economic slowdown to pull the world’s largest economy out of the hottest inflationary environment in 40 years.

Traders have been pricing in expectations the Fed will lower interest rates because of the banking crisis that sprung out of this month’s collapse and seizures of Silicon Valley Bank and Signature Bank. Recent Fed funds futures pricing indicated markets were looking for policymakers to reduce rates by 1 percentage point by the end of 2023. 

“We don’t think such cuts are coming,” Li wrote. 

BlackRock said the February consumer price index confirmed its view that inflation “is still not on track” to settle at the Fed’s 2% target. The February CPI report showed seasonally adjusted prices climbed 0.4% from January. The headline figure rose to 6% year-over-year but cooled from January’s 6.4% print. 

Stocks “have held up” on hopes for rate cuts, but sticky inflation dashes the potential for reductions by policy makers, BlackRock said. The Fed this month delivered its ninth straight rate increase, pushing its benchmark rate at 4.75% to 5% from zero in March 2022. 

The Fed could cut rates only if a more serious credit crunch develops and causes an even deeper recession than is expected, said BlackRock. 

“The Fed and other central banks made clear banking troubles would not stop them from further tightening,” said Li.

This month, the European Central Bank, the Bank of England, and the Swiss National Bank all raised their respective rates by 0.5%. The Swiss central bank pushed forward with a rate hike after it helped with UBS with its acquisition of Credit Suisse in a deal valuing the troubled lender at $3.25 billion. 

The turmoil that’s shaken US and European banks imply higher borrowing costs and tighter credit availability and are part of the economic and financial damage that BlackRock has flagged. About $500 million in deposits had rushed out of “vulnerable” US banks after SVB’s implosion, according to JPMorgan. 

“That damage is now front and center – central banks are finally forced to confront it,” said Li. “We see major central banks moving away from a ‘whatever it takes’ approach, stopping their hikes and entering a more nuanced phase that’s less about a relentless fight against inflation but still one where they can’t cut rates.” 

BlackRock remains underweight stocks in developed markets as it doesn’t see those markets reflecting the damage it anticipates. It also prefers inflation-linked bonds.