Fed Catches Up With Restart Reality
The Fed has now made a meaningful upgrade to its inflation outlook by embracing a more pronounced overshoot of its 2% target. We view this upgrade as the Fed catching up with the restart dynamics. While the upgrade largely reflects the incoming data since the last meeting, there is a notable change: The Fed now sees the ongoing inflation surge as contributing to achieving its objective as opposed to focusing on its transitory nature.
The Fed surprised markets by embracing higher inflation and heralding a lift-off from zero rates in 2023, rather than 2024. We think this could add to its new framework's credibility as long as last week's fall in inflation expectations does not persist.
01 FED'S OUTLOOK SHIFT
Fed officials embraced higher 2021 inflation as contributing to their medium-term policy objective, opening the door to a 2023 lift-off.
02 CONSISTENT WITH NEW FRAMEWORK
We see this shift as consistent with the Fed's new framework, implying a much more muted response to inflation and supporting risk assets.
03 DATA WATCH
Global purchasing managers' index (PMI) and other sentiment data this week will help investors gauge the status of the economic restart.
THE BOTTOM LINE
Our bottom line: We believe the Fed's new outlook will not translate into significantly higher policy rates any time soon. This, combined with the powerful restart, underpins our pro-risk stance. Large cash balances held by investors and no obvious signs of financial vulnerabilities give us additional confidence. We prefer to take risk in equities and remain underweight bonds on valuations. Within equities, we have been warming up to cyclical stocks as the restart broadens globally, as reflected in an overweight call on UK equities and our upgrading of European equities to neutral earlier this year. We may see bouts of market volatility as markets test the Fed's resolve to stay "behind the curve" on inflation. Any temporary spikes in rates could challenge emerging market assets in particular, but we advocate staying invested and looking through any turbulence as the New nominal plays out.
Source: Blackrock.com
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