Markets Rallying Prematurely on Fed Pivot Hopes: BlackRock

What You Need to Know

Equities have yet to fully reflect recession and earnings risk, according to BlackRock.
Interest rates have hit recession-triggering levels, the firm says.
Central banks will stop tightening only when the damage is clearer, its analysts predict.

Markets are rallying prematurely on hopes that Federal Reserve tightening may end soon, BlackRock analysts said in a market commentary Monay, a week after the firm predicted a looming recession will keep stocks from enjoying the typical post-midterm election lift.

The firm maintains underweight positions in developed market stocks and bonds.

Midterms often lead to legislative gridlock in Washington, which prevents policy changes that could spook stocks, BlackRock Investment Institute analysts said in their commentary last week.

“We don’t see that past playbook working this time due to the recession we expect from the Fed ratcheting up rates,” the firm said.

“We see a bigger problem for stocks than any potential positives from the midterm election outcome: a looming recession. We have argued how central banks rushing to hike policy rates to get inflation back to target would need to crush interest rate-sensitive parts of the economy first. That’s because higher inflation is driven by production restraints,” the note said.

“Recession will pressure other sectors in time, but we’re already seeing damage in important rate-sensitive sectors like housing. As mortgage rates soar along with the Fed’s aggressive rate hikes, the number of new housing starts is falling quickly. The slide in housing starts this year … is already steeper than past mega Fed rate-hike cycles such as in the 1970s and early 1980s — as well as the unwind of the mid-2000s U.S. housing boom,” the analysts wrote.

Their economic and market forecast Monday didn’t appear much sunnier.

“Markets are rallying on hopes policy tightening is nearing an end — prematurely, in our view. We think the Fed, like other developed market central banks, will only stop when the severe damage from rate hikes is clearer,” BlackRock analysts wrote.

“Rates have already hit levels that may trigger recessions, in our view. Plus, shrinking central bank balance sheets put selling pressure on long-term government bonds and risk causing market mayhem. That keeps us underweight stocks and government bonds.”