Stagflation ahead despite soft landing hopes, say 92% of fund managers

In the most optimistic corners of Wall Street, promising inflation numbers over the past week or so suggest that the Federal Reserve may be able to make a soft landing after all.

Yet there is no such belief among the big money managers, who are betting that an economic downturn with still-heated price pressures will define business next year.

As the closely watched portion of the Treasury yield curve sends new signs of contraction, stagnation is the consensus view among a whopping 92% of respondents to Bank of America Corp.’s latest fund manager survey.

At the same time, Citigroup Inc. is drawing a “Powell Push” scenario in which the Fed will be forced to hike even if growth slows, while BlackRock Inc. sees no chance of a soft landing in either the US or Europe.

The bearish stance comes even as recent data on employment as well as consumer and producer prices — along with decent corporate earnings — suggest that the Federal Reserve may actually be succeeding in its ambitious mission to raise borrowing costs without collapsing the business cycle.

For now, however, the institutional investor class will need to see conclusive evidence of a benign shift in the economy before they significantly alter their defensive positions in the nascent world of stocks and bonds.

“Central banks will overtighten and push economies into modest recessions, but stop hiking — before they’ve done enough to bring inflation all the way down to target — as the damage from rate hikes becomes clearer,” said Wei Li, chief investment strategist. globally. at BlackRock.

Li sees slowing growth in the U.S., lower earnings and increased price pressures, justifying the company’s underweight in developed market stocks and bonds, although it is willing to put money back into corporate credit. Her position is supported by investors at Bank of America, who overwhelmingly see stagflation on the horizon. The firm’s latest survey shows that they are historically underweight stocks — with tech stock positions at their lowest since 2006 — and overweight cash.

The pessimism contrasts with tenderness sparked by a US inflation report last week that suggested price pressures may be peaking. It increases the debate about whether the central bank has the flexibility to moderate the pace of interest rate increases.

The latter was dismissed with a parade of monetary officials this week. Among the highest hawks, 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 Bank President Mary Daly said a break in the hiking cycle was “off the table,” while Kansas City Bank President Esther George warned the Fed could find it increasingly difficult to tame inflation without triggering a recession .

As interest rate hikes ignite bear markets in stocks and bonds, the Fed has gone from bullish friend to newfound foe. And no dovish policymaking seems likely any time soon. Citi, for example, is pushing the idea of ​​a “Powell Push,” in which the Fed led by Jerome Powell is forced to raise interest rates because of still rampant inflation ahead.

“We categorize the environment as stagnant,” says Alex Saunders, Citi’s chief strategist. He recommends selling US stocks and credit and buying commodities and bonds in a Powell Push scenario.

Invesco is also treading carefully, skewing exposure to defensive stocks with overweight bets in U.S. Treasuries and credit ratings.

“Signs of becoming more ‘risk on’ would be a sign that the Fed is getting closer to ‘pausing’ rate hikes,” said Kristina Hooper, senior global market strategist at Invesco.

Even Morgan Stanley’s Andrew Sheets – who has a minority view that core inflation will fall to 2.9% by the end of 2023 – is not ready to take all the risks given the prospect of an economic slowdown. Still, he cites the mid-1990s as reason for optimism. During that time, a period characterized by rising inflation with rising interest rates, stocks, and Treasuries eventually managed to turn a big profit.

“Bears say soft landings are rare. But they happen,” Sheets wrote in his outlook for next year.

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