Markets will get ‘Fed up’ with too much tightening if growth slows as Powell shows most resolve since Paul Volcker, BlackRock says

Financial markets may stop tolerating the Federal Reserve’s tightening cycle as rate hikes make their way through the economy, BlackRock said in a statement on Thursday.

The coming months will be crucial in assessing how the real economy will respond to the Fed, said Rick Rieder, BlackRock’s chief investment officer of global fixed income.

But the typical lag between a sharp change in monetary policy and the impact on the economy will be longer than usual as fiscal stimulus continues to have an impact, he said. For now, the Fed will maintain rate hikes based on incoming economic data.

The Federal Reserve largely met investor expectations last week with a third straight hike of 75 basis points to bring interest rates to between 3% and 3.25%.

That was followed by hikes of 25 and 50 basis points earlier this year, while policymakers also signaled on Wednesday that further hikes will eventually take interest rates to nearly 5% by next year.

The pace of the Fed’s rate hikes and its switch from quantitative easing to quantitative tightening shows “an impressive determination and commitment rarely seen at the central bank since the days of Chairman Paul Volcker,” Rieder noted.

Indeed, Fed Chair Jerome Powell’s push to bring inflation back to a 2% target has drawn other comparisons to Volcker in recent days. During the Reagan administration, he notoriously hiked interest rates by as much as 20%, triggering two market crashes.

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That fear has now essentially become a reality on Wall Street, which has all but abandoned hopes of a dovish policy change from the Powell-led central bank any time soon.

“After two decades of over-focusing on its growth mandate (at the expense of inflationary risk), the tables have turned and the Fed is now pursuing inflation at the expense of growth,” said Gautam Khanna, head of US Multi Sector Fixed Income at Insight Investment.

“‘Don’t fight the Fed’ is the motto of the day, and if there’s no turning point in sight, does that mean something has to break before inflation collapses?” said Jamie Dutta, market analyst at Vantage.

But Rieder estimates that both financial markets and the economy will eventually tire of the tightening cycle, especially if growth slows significantly.

“Is the economy there yet? No, not yet, but investors are clearly watching every economic and corporate report and survey to see where inflection points present themselves (including global conditions),” he said.

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