Markets are pricing in at least 100 basis points of interest rate cuts next year, starting in the second quarter. One strategist thinks those bets are "overdone."
"That is really aggressive," BlackRock Investment Institute global chief investment strategist Wei Li said at a media roundtable on Tuesday. "Something will have to go seriously wrong for that to come through. So we do think that the Fed will cut rates, probably in the second half of next year, but how many cuts they will deliver will be quite a bit less compared with the old economic cycles, old recessions."
As of Tuesday, markets have priced in a 68% chance of at least 100 basis points in cuts over the next year. A month ago, investors had priced in just a 37% chance, per the CME FedWatch tool.
But Li says the Fed will need to hold back on aggressive cuts next year to stop "further inflationary pressure."
In the past year, Americans have consistently opened up their wallets at a more aggressive pace than projected, leading to economic expansion in 2023, a year many initially thought would end in recession. A central bank that's quick to soften policy could allow for economic growth too far above trend.
Jean Boivin, the head of the BlackRock Investment Institute, noted that too much of the current market moves have centered around comments from central bankers.
"One other aspect of the overdone cuts is that when you look at the sequencing in which this has been priced in and what has been driving that, a lot of it is like reading the tea leaves of what Fed speakers are saying, in an environment where I think the framing is a big question mark, and a big uncertainty," Boivin said. "And I think the reality is central bankers don't necessarily know much more than we do about what's going to happen next next year.
The Fed's unpredictable path could lead to more volatility, particularly in the bond market. The 10-year Treasury yield (^TNX) has swung dramatically throughout the fall as investors speculate on the Fed's path. BlackRock also believes the uncertain nature of the post-pandemic economy will be a key contributor to further volatility in 2024.
BlackRock declined to take a view on whether the US economy would slip into a recession or whether a soft landing was possible.
"What matters most in our view, is that the environment implies persistently higher interest rates and tighter financial conditions," the firm wrote in its 2024 outlook.
Josh Schafer is a reporter for Yahoo Finance.
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