Debt ceiling drama and cracks caused by rate hikes could send the stock market lurching towards a sell-off as volatility batters investors, BlackRock says

• The debt ceiling crisis will help send stocks through another wave of volatility, BlackRock warned.
• That's because debt ceiling pressures are colliding with existing financial stress from rate hikes.

The US debt ceiling crisis and financial cracks stemming from higher interest rates will send the stock market through another wave of volatility and a potential sell-off, BlackRock warned.

In a note on Monday, strategists pointed to growing signs of unease in financial markets as the deadline to raise the US borrowing limit ticks closer.

Bond markets are already seeing more volatility than they were in 2011, the last time the US risked a debt default. In that instance, the S&P 500 fell around 17% between July and August 2011.

That means the current debt ceiling crisis could spark similar volatility in markets, strategists warned – which will add on top to the existing financial stress stemming from higher interest rates in the economy.

"The debt ceiling showdown is set to increase the volatility in financial markets that has defined the new regime. Any selloff may cause risk assets to better price in the economic damage we expect from interest rate hikes," the note added.

But BlackRock isn't bearish on all stocks. In fact, it's overweight emerging market stocks, which could benefit in the short term from China's economic restart, central banks nearing the end of their policy tightening, and a weaker US dollar.

By contrast, BlackRock is underweight developed market stocks, citing financial and economic damage caused by rates hikes as well as corporate earnings forecasts not fully reflecting a recession.

BlackRock has been forecasting a new regime of volatility in financial markets for months, thanks to the Fed's aggressive rate hikes of 2022. The Fed raised interest rates over 1,700% over the past year to control inflation, a move that's raised the risk of recession and has made the old investing strategies obsolete, strategists warned.

Those risks have been compounded with the potential for a US debt default, with Congress potentially having less than a month to raise the national borrowing limit before the government could runs out of money. That scenario could easily spark an economic crisis, experts warn, given the wide role US debt takes on in global financial markets.

Policymakers are still sparring over how to raise the debt ceiling, with President Biden and congressional leaders expected to meet this week to discuss a possible solution.

Republicans have proposed a short-term debt limit increase of $1.5 trillion, in exchange for about $4.5 trillion in government spending cuts, while the White House has rejected any conditions on raising it.