The Fed will likely choke off an economic rebound then change course as markets enter a new era of volatility, BlackRock says

• Market volatility will continue as the Fed struggles to tame inflation and spur a rebound, BlackRock says.
• Analysts said in a report Monday that central banks are tackling inflation the wrong way.

BlackRock warned Monday of increased market volatility as the Federal Reserve and other central banks try to rein in inflation and avoid a steep downturn.

Analysts at the world's largest asset holder said that policymakers are tackling inflation the wrong way, by using rate hikes to address problems caused by production constraints.

"The Federal Reserve, for one, is likely to choke off the restart of economic activity — and only change course when the damage emerges," according to the BlackRock Investment Institute's midyear outlook.

Much of the present-day economic constraints began with the onset of the coronavirus pandemic and were further exacerbated by Russia's invasion of Ukraine, it noted.

As the Fed zigs and zags on policy, BlackRock sees high macro and market volatility, with stocks suffering if rate hikes trigger a growth slowdown. But if policymakers accept more inflation, bonds would fall.

"Either way, the macro backdrop is no longer conducive for a sustained bull market in both stocks and bonds, we believe," BlackRock said.

The stark warning comes as experts expect inflation to have sped up yet again in June, edging closer to 9% year-over-year.

For long-term portfolios, BlackRock is still overweight on stocks and underweight on government bonds. But in the near term, stocks are a "tactical underweight" due to the risk of an economic slowdown.

Analysts also noted that investors should be quick to adapt to quick market changes, asserting that they "expect growth to stall and see earnings estimates as overly optimistic."

"The Great Moderation, a period of steady growth and inflation, is over, in our view. Instead, we are braving a new world of heightened macro volatility – and higher risk premia for both bonds and equities."