Fed is 'so far from equilibrium' as markets await rate guidance, BlackRock's Rick Rieder says

By Christine Idzelis

On Wednesday, the Fed will announce its policy decision and release forecasts for interest rates

Investors have been re-evaluating when the Federal Reserve may start lowering interest rates, as the "last mile" of bringing down inflation is proving difficult, according to BlackRock's Rick Rieder.

With the central bank's two-day policy meeting under way, some Fed officials may be wary about cutting rates due to signs of stickier inflation in the services sector of the U.S. economy, Rieder, who is chief investment officer of global fixed income and head of the global allocation investment team at BlackRock, the world's largest asset manager, said by phone.

"I still think Powell is going to suggest that they can still move, and give some sense that June is a likely time frame to start," Rieder said. In his view, Powell will probably express "a willingness and desire" to reduce the central bank's benchmark rate this year, as "he's so far from equilibrium," or a normalized rate, after tightening monetary policy to battle inflation.

While markets expect the Fed will announce on Wednesday that it's keeping its benchmark rate at the current 22-year high, traders in the federal-funds-futures market see an almost 56% probability that the Fed could begin reducing rates as soon as June, according to the CME FedWatch Tool, at last check. Traders are pricing in about three rate reductions of a quarter percentage point each in 2024, with chances of fewer cuts than that leaning a bit higher than the probability of more than three by year-end.

Investors' anticipation for the Fed's release Wednesday of its summary of economic projections is meanwhile running high, as the forecasts will provide a window into whether inflation worries have altered how many rate cuts officials are penciling in this year, after signaling three in December.

Projections for only two rate cuts in 2024 could lead to a knee-jerk reaction of disappointment in markets, according to Rieder, who estimated a 25% to 30% chance of the Fed signaling such a forecast.

Rieder said he's also keeping "a keen eye" on what the summary of economic projections will show about the longer-run fed-funds rate, which has been estimated at 2.5% in past forecasts.

"There is a reasonable chance that notches higher," he said, which would "signal higher interest rates for a longer period of time."

The Fed has held its current policy rate at a target range of 5.25% to 5.5% - well above its longer-run projections - in an effort to bring inflation down toward its 2% target.

Inflation, as measured by the consumer-price index, increased 0.4% in February for a year-over-year rate of 3.2%, according to a report last week from the Bureau of Labor Statistics. Core inflation, which excludes food and energy prices, rose 0.4% last month for an annual pace of 3.8%.

A reading on February inflation from the Fed's preferred gauge, core data from the personal-consumption-expenditures price index, will be released on March 29. Core PCE data showed that inflation rose in January but eased to 2.8% year over year.

"You have to build into your calculus as an investor" today that service-level inflation is still too high, Rieder said. By contrast, he said that goods inflation is running at a negative rate after the Fed's aggressive monetary tightening.

Rieder worries the central bank's higher rates are putting pressure on lower-income borrowers, local banks and commercial real estate.

The Fed's rate hikes are becoming a drag on cash-strapped consumers with lower incomes, who are struggling with higher borrowing costs as a result of the tighter monetary policy, he said.

Read: Credit-card and car-loan delinquencies are at their highest point in more than a decade

Todd Vasos, chief executive officer of discount retailer Dollar General Corp. (DG), said last week that "customers are continuing to feel the impact of the last two years of inflation, which we believe is driving them to make tradeoffs in the store," according to a FactSet transcript of the company's post-earnings call with analysts.

As for pressure on local banks, shares of troubled New York Community Bancorp Inc. (NYCB) plunged at the end of January and continued to slide in February before the bank got $1 billion in an equity investment anchored by former Treasury Secretary Steven Mnuchin's investment firm Liberty Strategic Capital.

'Undue pressure'

Interest-rate increases by the Fed used to have a broader cooling effect before the U.S. economy shifted to become more services-oriented as opposed to manufacturing-based, according to Rieder.

The U.S. stock market has also become less sensitive to rate hikes when viewed through the lens of the S&P 500, as the widely followed index is heavily weighted in so-called Big Tech companies that have a lot of cash to fund their growth instead of relying on borrowing to do so, he said.

The evolution of the U.S. economy and markets means the Fed may confront having to make "more extreme moves to get the benefit" it's trying to achieve through higher rates, which risks putting "undue pressure on the parts of the economy" that are more sensitive to them, according to Rieder.

The S&P 500 has risen more than 8% this year, driven by outsized gains from a few megacap companies known as Big Tech, including Nvidia Corp. (NVDA), Meta Platforms Inc. (META), Amazon.com Inc. (AMZN) and Microsoft Corp. (MSFT), FactSet data show, at last check.

Read: Why S&P 500's consumer-discretionary sector is 'left behind' in U.S. stock market

The S&P 500 SPX is trading near its record closing peak of 5,175.27 on March 12, even as Treasury yields have climbed this year, according to Dow Jones Market data. The yield on the 10-year Treasury note BX:TMUBMUSD10Y has climbed 47.9 basis points this year through Monday to 4.339%, based on 3 p.m. Eastern time levels, according to Dow Jones Market Data.

Rieder, who is the lead portfolio manager for the BlackRock Flexible Income exchange-traded fund BINC, said he's been looking for more yield globally in areas such as high-yield corporate credit and securitized debt. The actively managed fund's portfolio is running at an annual yield of around 6.6%, according to Rieder.

The ETF, whose assets under management have jumped to around $3 billion since it launched in May, has returned a total 0.5% this year through Monday, according to FactSet data. The fund is beating the broad market for U.S. investment-grade debt, with the iShares Core U.S. Aggregate Bond ETF AGG down 1.7% on a total-return basis over the same period.

Credit quality, by a number of measures, is "the best it's been in decades," Rieder said. "Credit is still attractive, even though the spreads are not."

-Christine Idzelis

This content was created by MarketWatch, which is operated by Dow Jones & Co. MarketWatch is published independently from Dow Jones Newswires and The Wall Street Journal.

(END) Dow Jones Newswires

03-19-24 1448ET

Copyright (c) 2024 Dow Jones & Company, Inc.