Inflation isn’t going anywhere, and higher rates could spark a 12% downturn for stocks in the coming year, veteran strategist says

Households and companies may be breathing a sigh of relief as borrowing costs move lower, but they shouldn’t get comfortable because rates and inflation are going to remain high — and that reality could spark a big drop for stocks in the next year, Wall Street veteran Bill Blain said.

Blain, a longtime strategist and principal of Wind Shift Capital Advisors, said he sees a rocky 12 months ahead for the stock market. He said the Fed isn’t poised to take interest rates as low as markets think, and borrowing costs could indeed rise from here. That could crimp lending, slow dealmaking, and take US and global stocks down 7%-12%, he told B-17 in an interview.

“I think the crunch that we face is what happens when interest rates start to rise, and governments are not in a position to continue boosting the economy in an interest rate rising environment because they’ve lost the support of markets,” Blain said.

In the event of a credit crunch, he doubts the US will be able to dole out stimulus as it did during the pandemic, due to concerns about the overall level of debt and the inflationary impact on the economy.

“It’s the reality that inflation is going to creep back into the global economy. Interest rates are going to have to rise,” he said.

A return to higher-for-longer

Blain’s forecast may sound counterintuitive to investors who have been pricing in ambitious rate cuts from the central bank.

But the US economy faces too many inflationary pressures over the medium-term to warrant aggressive policy easing, Blain said.

For one, the federal debt has swelled to a historic $35 trillion. Economists have flagged rapid government borrowing as a factor that risks stoking inflation.

Meanwhile, supply chain issues linger, and given rising geopolitical tensions, world trade looks on track to be more fragmented, which can also prop up inflation.

Finally, the threat of high tariffs from former President Donald Trump would impose a tax on nearly all imported US goods that economists say would end up being passed on to the consumer.

“I think inflation is going to be more ingrained, as it was in the 1970s and early ’80s,” Blain said. “It’s going to be a very, very different economy and we just need to get used to it.”

Other forecasters have warned inflation could be much stickier than markets expect. Core inflation is unlikely to fall back to the Fed’s 2% target, BlackRock strategists said in a recent note, pointing to large US budget deficits and other “mega-forces” that will propel prices higher.

That means investors waiting for a return to near-zero borrowing costs to return will be in for a rude awakening. Blain thinks interest rates will hover between 4.5%-6% in the “new normal,” causing interest payments to “go through the roof” when compared to pre-pandemic levels, he said.

Companies could take a hit as the credit crunch plays out. Though Blain said he wasn’t necessarily calling for a market crash or a wave of “zombie” firm failures, he thinks dealmaking in the private equity space could slow, while some of the most financially troubled firms risk insolvency.

Meanwhile, stock prices will head back to a much more reasonable level as the speculative bubble in asset prices pops.

“I think there’s still a massive hangover from the 2010 to 2022 era of ultra-low interest rates and easing and I think stocks are generally still priced for speculation and lower interest rates,” he said of his predicted downside to the market. “I don’t think there’s any reason to really expect major interest rate cuts.”

Still, investors are feeling pretty positive about the short-term outlook for stocks and lower rates. Markets see a 95% chance the Fed will cut rates by 25 basis points at the November policy meeting, and a 72% chance that rates will be 50 basis points lower by the end of the year, according to the CME FedWatch tool.