BlackRock has moved to a neutral stance on developed market stocks in light of increased risks that hawkish central banks will choke global growth. 
The asset management house, which is the largest in the world thanks to running around $10trn, recently said it was reducing risk in its portfolios because of “a worsening macro outlook”.
In its latest update, BlackRock revealed it has since gone neutral on developed market equities, having previously held a modest overweight, citing recent comments from Federal Reserve chair Jerome Powell as the reason.
Last week, Powell said in a Wall Street Journal conference that the central bank would persist with interest rate hikes until inflation begins to fall back towards a healthy level. “What we need to see is inflation coming down in a clear and convincing way,” he said. “And we’re going to keep pushing until we see that.”
Noting that this suggests the Fed saying it will bring down inflation “at any cost”, BlackRock strategists replied that “reality will be more complex”.
Firstly, the current supply-driven inflation – caused by a combination of post-pandemic bottlenecks and the conflict in Ukraine – means central banks face “the sharpest policy trade-off in decades”: whether to risk choking off growth through sharply higher interest rates or to accept living with supply-driven inflation.
“The Fed’s hawkish pivot this year has been stunning and pronouncements on reining in inflation have become regular fare. Chair Jerome Powell just last week said the Fed would keep hiking rates until inflation is ‘tamed’ – a comment that dismisses any trade-off or the lagged effect of monetary policy on the economy,” the firm’s strategists said.
“The Fed now appears to be constraining itself to the hawkish side of policy options with such language, just as talking about the jump in inflation being ‘transitory’ last year boxed it in when inflation proved more persistent and forced a sharp pivot. We think the Fed could be forced into another sharp pivot later this year, which we expect rather than a recession. These Fed pivots are driving market volatility, in our view.”
China slowdown to ripple across globe
Secondly, the trade-off facing central banks looks even worse when put into context of a deteriorating global economic outlook, especially the recent hit to Chinese growth from the re-imposition of Covid lockdowns. This had already had a bigger economic impact than the global financial crisis and is starting rival the one from 2020.
“We think this will reduce growth in major economies and nudge up developed market inflation at a very inopportune time when higher inflation is already proving more persistent. We had already seen Europe at risk of recession, which prompted us to reduce risk a few weeks ago. As a result, we further downgrade developed market equities to neutral from overweight,” BlackRock said.
Market expectations are for the Fed funds rate to reach 3.1% over the coming year, which would be double where it started 2022, while market pricing for the European Central Bank tips it taking rates to close to 1.4%. If these paths prove accurate, then BlackRock thinks the market’s sell-off “makes sense”.
But the investment house thinks the Fed will only take rates to around 2.5% thanks to that expected dovish pivot later in 2022. Until the central bank starts that pivot, however, BlackRock does not see any meaningful catalyst for a sustained rebound in risk assets.
“The upshot? We further reduce portfolio risk after having trimmed it to a benchmark level a few weeks ago with the downgrade of European equities. We are now neutral developed market equities, including US stocks,” its strategists finished. “But a dovish pivot by the Fed would spur us to consider leaning back into equities.
“Our change in view prompts us to keep an overweight to inflation-linked bonds from a whole-portfolio perspective. We prefer short-term government bonds for carry, and see scope for long-term yields to rise further as investors demand greater term premium for the risk of holding such debt in this inflationary environment. Overall we remain underweight US treasuries.”