Inflation dynamics are slowing down: BlackRock still does not believe that the US Federal Reserve’s 2 percent target will be reached

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• Inflation momentum in the US is slowing
• Still, BlackRock strategists do not believe the Fed will reach its 2 percent target
• Thiel: Longer-term structural changes will keep inflation high

After the US central bankers initially dismissed the high inflation as temporary, they took action in 2022. They raised the key interest rate in four large steps of 0.75 percent. In December, the US Federal Reserve took its foot off the gas and raised interest rates by a further 0.5 percentage points. However, there is still no end in sight to the rate hikes, even if the inflationary momentum slows down.

Inflationary pressures in the USA have weakened

In November, the inflation rate in the US fell to an annual low of 7.1 percent. Since June (9.1 percent), the upward pressure on prices has therefore weakened noticeably. This is raising hopes among investors that the US may have passed the inflation peak and that interest rate hikes may soon come to an end.

However, it remains to be seen whether this hope will come true, because the monetary watchdogs have signaled that they will tighten the reins further in 2023 – albeit with smaller interest rate increases. “We will stay the course until the job is done,” quotes tagesschau.de Fed Chair Jerome Powell, who has repeatedly emphasized in the past that the US Federal Reserve must have staying power in the fight against high inflation .

BlackRock strategists do not believe in reaching the 2% target

Despite the slowdown in inflation momentum, BlackRock strategists are currently warning of disappointment for investors betting on a sharp slowdown in inflation. While acknowledging that pricing pressures are easing faster than expected, Bloomberg reports, the money manager is not expecting inflation to fall toward the Federal Reserve’s 2 percent target.

Scott Thiel, chief fixed income strategist, expects US inflation to fall to just 3.50 percent towards the end of 2023 amid ongoing labor shortages, higher wages and falling inventories. This compares to 1-year CPI swaps at 2.38 percent and 10-year breakevens at 2.14 percent. “We just don’t think that’s enough,” quotes Bloomberg Thiel. “Volatility in CPI numbers is something the market should expect,” Thiel said. It will be difficult to name the figures for the monthly change. “But it’s probably easier to go from 7% to 5% than from 5% to 3%.”

BlackRock expects the US Federal Reserve to hike interest rates to 5% in the first half of 2023 before inflation settles at around 3% in the longer term. According to Thiel, there are longer-term structural changes that will keep inflation high, which is why there is no reason for the US Federal Reserve to be “anything but restrictive” for the time being. “Looking ahead, geopolitical risks, demographics and a move to net zero will keep inflation high,” Thiel said. “Should interest rates go from 5% to 3% in the next two years? Not in this environment.”

Recommendation for 2023

For 2023, given this environment, BlackRock recommends an underweight position in government bonds in favor of inflation-linked and investment-grade corporate bonds. In a forecast report, the asset manager suggested that investors should “maximally overweight” inflation-linked securities in longer-term strategic portfolios, according to Bloomberg. After performing poorly in 2022, there are now signs of a trend reversal – while government bonds offer little protection against an economic downturn.

“Key interest rates could stay higher for longer than markets expect,” BlackRock strategists led by Wei Li and Scott Thiel wrote in their analysis, as reported by Institutional Money. “In addition, investors will increasingly demand higher remuneration for holding long-dated government bonds.” In its forecast report, BlackRock notes that “so-called bond vigilantes” who protest monetary or fiscal policies seen as inflationary by selling bonds and thus increasing yields are back. “In the old manual, long-dated government bonds would be part of the package, as they have historically protected portfolios from recessions. Not this time, we think,” the strategists said.

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