Markets may be underestimating the threat of high inflation, BlackRock warns

BlackRock analysts issue gloomy forecast for US stock market

The U.S. stock market may face another turbulent year as investors are underestimating the threat of both stubbornly high inflation and elevated interest rates, according to BlackRock analysts. 

In a research note, the BlackRock strategists signaled they anticipate that inflation will continue to run hot in 2023. They also see little chance of the Federal Reserve cutting interest rates this year, even if the U.S. economy slides into a recession.

"Central banks are unlikely to come to the rescue with rapid rate cuts in recessions they engineered to bring down inflation to policy targets," they wrote in a research note. "If anything, policy rates may stay higher for longer than the market is expecting."

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The gloomy forecast comes after a brutal year for the stock market, its worst since the 2008 financial crisis. All three indexes tumbled in 2022, snapping a three-year win streak. 

US stock market

Traders work on the floor of the New York Stock Exchange (NYSE) on June 10, 2022 in New York City.  ((Photo by Spencer Platt/Getty Images) / Getty Images)

The Dow Jones Industrial Average ended the year down 8.8%, the best of the three. The S&P 500 sank 19.4%, while the tech-heavy Nasdaq Composite plunged 33.1%. 

Stocks have rallied so far in early 2023, with the S&P up about 2.25% on Tuesday from the start of the year following the better-than-expected December jobs report that showed wage growth slowed markedly last month. 

A separate report from the Institute for Supply Management indicated that the services sector contracted in December, fueling hopes that the Fed will pause its aggressive interest-rate hike campaign earlier than previously expected. 

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Jerome Powell Fed

Federal Reserve Chair Jerome Powell attends a press conference in Washington, D.C., on July 27, 2022.  (Photo by Liu Jie/Xinhua via Getty Images / Getty Images)

However, the BlackRock analysts see little optimism ahead for the markets and remain skeptical that central bank policymakers will cut interest rates in the event of a downturn. 

"That’s why the old playbook of simply ‘buying the dip’ doesn’t apply in this regime of sharper trade-offs and greater macro volatility," they wrote. "The new playbook calls for a continuous reassessment of how much of the economic damage being generated by central banks is in the price."

The strategists also predicted that high inflation will persist over the next year, despite the steeper interest rates designed to tame out-of-control consumer prices. The Labor Department reported last month that prices rose 7.1% in November; while that marks the slowest pace in nearly two years, it's about three times higher than the Fed's target goal. 

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"Even with a recession coming, we think we are going to be living with inflation," they wrote. "We do see inflation cooling as spending patterns normalize and energy prices relent – but we see it persisting above policy targets in coming years."