BlackRock: Short-Term Market Risks – The Catalyst for an Overweight Return

Of Eleftheria Kourtali

Markets are exaggerating in terms of central bank movements and are already preparing for very aggressive interest rate hikes, as BlackRock notes in the new strategy report. She estimates that the tightening will be much milder than currently priced – something that will relieve the markets in the long run, however, this excess of markets leads her to be cautious about the course of risk assets in the near future.

In particular, as he points out, the European Central Bank is going to confirm this week that interest rate hikes are starting and markets expect them to continue for most of 2023. The Federal Reserve seems to be reaching maximum interest rates by the end of this year. The sum of interest rate hikes will eventually prove to be historically low, BlackRock estimates, as central banks will choose to live with inflation rather than “strangle” growth. The problem; Markets are preparing for a very aggressive monetary tightening and are quickly realizing the risks of this process. However, this excess in the markets makes it neutral for the shares in the short run.

As BlackRock points out, the ECB and the Fed both need to quickly normalize policy from the emergency support measures adopted when the pandemic first struck. They both deal with their confidence as they choose to embark on their play activities. The difference for the two central banks, however, is the factors of inflation. Inflation in the euro area is mainly due to higher energy and food bills worsened by the war in Ukraine. This will be eliminated in the medium term, according to BlackRock, as Europe finds new sources of energy and food. In the US, inflation is broader, with increases due to goods and energy. “We see US inflation as persistent and expect it to stabilize at higher levels than before Covid,” he said.

We have entered an era where production constraints have become the dominant drivers of inflation, BlackRock adds. “Think of the bottlenecks and the difficulties in production, supply, transportation and staffing. Both central banks have not yet recognized the sharp trade-off when trying to contain this type of inflation with interest rate hikes, which is the “Push growth and jobs or live with higher inflation than before the pandemic.”

BlackRock does not see a positive scenario where inflation remains close to 2%, while unemployment remains low and growth continues to rise. This leaves the door open for markets to expect excessive tightening at any sign of persistent inflation, tight labor market or economic strength – and makes it neutral in the short term.

And the situation, as he points out, is more intense in Europe. Markets expect the ECB to raise interest rates by much of 2023 to curb a record 8.1% inflation in May. BlackRock, on the other hand, sees the ECB raising interest rates rapidly from negative ground but then stalling in the face of a recession caused by Europe’s energy crisis similar to that of the 1970s. European Union decision to ban Most crude oil imports from Russia are the latest example of how the West is determined to wean itself off of Russian energy. This raises oil prices and slows growth. “As a result, we are seeing a significant slowdown in the euro area economic activity and we therefore believe that market expectations for ECB interest rate hikes are too aggressive,” BlackRock said.

Market pricing for Fed rate hikes has fallen recently amid expectations that inflation is certain to fall. This pushed the stock recovery from the 2022 lows and stopped the US dollar rally. In other words, the markets moved as if inflation were yesterday’s story. BlackRock, however, disagrees. Certainly, inflation is expected to fall from a high of 40 years. But it will persist and exceed the Fed’s target of 2% in the coming years. Thus, it sees a risk in the short term for a sharp recovery in market expectations for interest rates, as the data show the persistence of inflation and as the Fed continues to speak aggressively about inflation.

What does this mean for investment? The current volatile macroeconomic and market landscape will continue, in BlackRock’s view. He estimates that central banks will eventually give a historically silent answer to inflation. This supports its baseline scenario for the preference of shares over government bonds in the long run. However, in the short term, purchases will be difficult. “When and in the coming months we see another sharp turn in monetary policy, towards milder rhetoric, it will also be the catalyst for a return to the overweight stance for equities,” BlackRock concludes.