BlackRock says markets will get 'Fed up' with too much tightening as growth slows, with Powell showing the most resolve since Paul Volcker

Paul Volcker
Paul Volcker, former Fed Chair 1979 to 1987.Bettmann / Getty Images
  • Slow growth and too much tightening from the Fed will frustrate markets and the economy, BlackRock says.

  • "Still, we do think that markets, and consequently the economy, will become 'Fed up' with too much tightening," according to a note.

  • The current Fed's campaign to tackle inflation also drew comparisons to the one engineered by former Fed Chair Paul Volcker.

Financial markets may stop tolerating the Federal Reserve's tightening cycle while rate hikes work their way through the economy, a note from BlackRock said Thursday.

The coming months will be key to assessing how the real economy reacts to the Fed, said Rick Rieder, BlackRock's chief investment officer of global fixed income.

But the typical lag between a strong change in monetary policy and effects on the economy will be longer than usual as fiscal stimulus continues to have an impact, he said. For now, the Fed will keep hiking rates based on the economic data that comes in.

"Still, we do think that markets, and consequently the economy, will become 'Fed up' with too much tightening, if growth (and employment) are tangibly slowing alongside of these tighter policy moves," Rieder warned.

The Federal Reserve essentially met investor expectations this past week with a third straight 75-basis-point increase to bring the fed funds rate to 3%-3.25%.

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

The Fed's pace of rate hikes and its pivot from quantitative easing to quantitative tightening show "an impressive resolve and a commitment rarely seen at the central bank since the days of Chairman Paul Volcker," Rieder noted.

In fact, Fed Chair Jerome Powell's drive to bring inflation back down to a 2% target has drawn other comparisons to Volcker in recent days. He notoriously hiked interest rates as high as 20% during the Reagan administration and spurred two market crashes as a result.

That fear has essentially now become reality on Wall Street, which has all but abandoned hopes of a dovish pivot from the Powell-led central bank in the near future.

"After two decades of being hyper-focused on its growth mandate (at the expense of inflation risks), the tables are turned, with the Fed now pursuing inflation at the expense of growth," said Gautam Khanna, head of US multi Sector fixed income at Insight Investment.

And Powell is showing signs that this Fed is willing to take the residual effects in stride as rates move higher, seemingly accepting the Volcker-esque roll with a laser focus on inflation.

"'Don't fight the Fed' is the phrase du jour, and with no pivot in sight, does that mean something has to break before inflation breaks?" said Jamie Dutta, market analyst at Vantage.

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

"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 are presenting themselves (including global conditions)," he said.

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