Strategists at BlackRock’s Investment Institute warned in a note published Tuesday that the Federal Reserve’s rate hiking in the face of decades-high inflation is poised to stall economic growth without necessarily solving the inflation issue.
“The Fed seems dead set on raising rates this year to levels that, in our view, would clearly slow the economy,” the BlackRock strategists stated. “It seems to be responding to the ‘politics’ of current high inflation, but the Fed isn’t actually looking to slow the economy.”
BlackRock anticipates that if growth shows signs of slowing, the Federal Reserve is likely to change course in its path to rein in inflation. But even if the macroeconomic environment prompts the Fed to pause its hiking cycle, the “risk of zero or negative growth and persistent inflation” would remain.
That is because, the analyst argued, high core inflation rates have been driven by “unusually low production capacity in an incomplete restart following the pandemic” rather than overheating demand.
“The Fed isn’t looking for a recession, even though in our view one would be needed if it wanted to drive inflation back down to 2%,” the firm state. “So we expect the Fed to change course once it becomes clear growth has stalled.”
Fed Chair Jerome Powell emphasized that officials were not trying to induce a recession in remarks to reporters last week after the central bank raised its benchmark interest rate last week by 75 basis points.
“This reflects the Fed’s lack of acknowledgment of the policy trade-off,” the Blackrock analysts stated, defining the trade-off as a choice to either “slam down activity or live with persistent inflation while production capacity recovers.”
Other U.S. central bank officials have acknowledged that the risk of a slowdown is present but remain optimistic that price stability can be restored without compromising economic growth.
St. Louis Fed President James Bullard, a proponent of aggressive Fed action to bring down inflation, said at an event on Monday at the AXA-Barcelona School of Economics in Barcelona, Spain that he hopes the central bank can orchestrate the the same result it did in November 1994, when then Fed Chair Alan Greenspan raised rates seven times within 13 months from 3% to 6%.
“That tightening episode caused some disruption that year,” Bullard said. “However, I have always felt that it set up the U.S. economy for a stellar performance in the second half of the 1990s. … I hope we can get something like that this time.”
Wall Street does not appear to share the same optimism.
The Fed’s interest rate hike last week spurred a wave of recession calls and sent markets into disarray.
Deutsche Bank, the first of Wall Street heavyweights to predict a U.S. recession in 2023, has since moved up its timeline for when it expects the economy to enter a trough.
“Since that time, the Fed has undertaken a more aggressive hiking path, financial conditions have tightened sharply and economic data are beginning to show clear signs of slowing,” Deutsche Bank Chief U.S. economist Matt Luzzetti wrote in a note to clients on Friday.
Economists at Goldman Sachs lowered their baseline growth outlook, and are increasingly concerned about a “forceful” response by the Fed if energy prices continue to rise — even if economic activity slows.
“We now see recession risk as higher and more front-loaded,” Goldman Sachs Chief Economist Jan Hatzius wrote in a note to clients Tuesday.
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Alexandra Semenova is a reporter for Yahoo Finance. Follow her on Twitter @alexandraandnyc
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