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BlackRock Says There Is No 'Soft-Landing': Central Banks Will Have To Plunge Economy Into A Deep Recession To Stop Inflation

In the current uncertain macroeconomic environment, the world's largest asset manager, BlackRock Inc NYSE:BLK, predicts there won't be a "soft landing" and prefers to be overweight investment grade (IG) credit over standard equities.

For the uninitiated, IG securities in the financial industry are government and private fixed-income instruments that have a minimal risk of default, such as bonds and notes.

Credit rating companies such as Standard & Poor's and Moody's use a relative scale to establish what is considered IG.

The firm prefers IG credit over equities on a tactical horizon because IG credit can withstand a substantial slowdown in growth while equities don't appear to be priced for that type of risk. BlackRock also anticipates a new market regime with increased volatility developing.

Related: BlackRock's CEO Just Dumped $20M In Shares: Here's What Happened Last Time He Did It

"First," the firm notes, "yields on IG credit have risen, making for improved valuations and a larger cushion against defaults. Second, balance sheets are strong, we think. Third, supply is low, and we see only moderate refinancing risks."

In July, the U.S. economy added 528,000 new jobs, doubling analyst projections. Despite a slight decline in labor force participation and a slight increase in pay, the labor market has not yet returned to normal.

The markets are pricing in the odds of a Federal Reserve rate hike of 75 basis points in September, slowing the rally in stocks and causing bond yields to shoot up. The firm believes the markets seem to anticipate that a modest contraction will lead to declining rates and lower inflation.

But, "We don't think such a 'soft landing' is likely in a volatile macro regime shaped by production constraints," BlackRock analysts wrote. "Central banks will have to plunge the economy into a deep recession if they really want to squash today's inflation -- or live with more inflation. We think they'll ultimately do the latter -- but they are not ready to pivot yet. As a result, we see lower growth and elevated inflation ahead."

If this happens, bond yields will go up and equities will be at the risk of another pitfall.

The firm said it would turn positive on equities again if there was a dovish pivot by the central banks when faced with a big growth slowdown, "A definite sign that [the Fed] will live with high inflation."

Photo: lem via Shutterstock

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