(Bloomberg) — In the most optimistic corners of Wall Street, promising inflation data over the past week or so suggests the Federal Reserve may be able to achieve a soft landing after all.
Most Read by Bloomberg
Yet such conviction is not prevalent among big money managers, who are betting that an economic downturn, fueled by still-hot price pressures, will define trading next year.
With a closely watched portion of the Treasury yield curve sending fresh recession signals, stagflation was the consensus view among a whopping 92 percent of respondents to Bank of America Corp.’s latest survey of fund managers.
At the same time, Citigroup Inc. paints a “Powell push” scenario in which the Federal Reserve will be forced to hike even if growth collapses, while BlackRock Inc. sees no prospect of a soft landing in either the US or Europe.
The bearish stance comes even as recent employment data and consumer and producer prices — combined with decent corporate earnings — suggest the U.S. central bank may actually succeed in its onerous mission to raise borrowing costs without collapsing the business cycle. .
Still, for now, the professional investment class will need to see more convincing evidence of a benign change in the economic trajectory before significantly changing its defensive stance in the fractured world of stocks and bonds.
“Central banks will tighten too much and push economies into a moderate recession, but they will stop growing — before they’ve done enough to bring inflation down to target — as the damage from rising interest rates becomes clearer,” Wei said Li, Global Chief Investment Strategist at BlackRock.
Li sees slowing U.S. growth, lower earnings and increased pricing pressures, justifying the firm’s underweight in developed-market stocks and bonds, although it is willing to put some money back into corporate credit. Her stance is supported by Bank of America investors who overwhelmingly see stagflation on the horizon. The firm’s latest research shows that the stock is historically underweight — with tech stocks at their lowest since 2006 — and overweight cash.
The pessimism contrasted with a bout of simmering fueled by last week’s US inflation report, which suggested price pressures may be peaking. That adds to the debate over whether the Fed has room to ease the pace of rate hikes.
The latter was promptly fired by a parade of cashiers this week. Among the most furious, St. Louis Fed President James Bullard said policymakers should raise interest rates to at least 5%-5.25% to curb inflation. It came after San Francisco Federal Reserve President Mary Daley said a pause in the growth cycle was “off the table,” while Kansas City Federal Reserve President Esther George warned the Fed could be increasingly -difficult to tame inflation without causing a recession.
Read more: Bullard sets tone for Fed officials, signaling hikes will continue
As rising interest rates spark bear markets in stocks and bonds, the Federal Reserve has turned from bullish friend to newfound foe. And it doesn’t look likely to get down to dovish politics any time soon. Citi, on the one hand, touts the idea of a “Powell push,” with the Jerome Powell-led central bank forced to undermine growth by raising interest rates because of still-raging inflation.
“We classify the environment as stagflationary,” according to Citi strategist Alex Saunders. He recommends selling US stocks and credit and buying commodities and bonds in a Powell squeeze scenario.
Invesco is also treading carefully, shifting its exposure to defensive stocks with overweight bets in U.S. Treasuries and investment-grade credit.
“Signals that the Fed is approaching a ‘pause’ in rate hikes would signal more ‘risk on,'” said Christina Hooper, chief global market strategist at Invesco.
Even Morgan Stanley’s Andrew Sheets, who maintains a minority view that core inflation will fall to 2.9% by the end of 2023, is not yet ready to take full risk on the prospect of an economic slowdown. Still, he cited the mid-1990s as reason for optimism. Then, an era marked by high inflation with interest rates rising, stocks and government bonds ended up making big gains.
“The bears say soft landings are rare. But they do happen,” Sheets wrote in his outlook for next year.
Most Read by Bloomberg Businessweek
©2022 Bloomberg LP