A BlackRock strategist said if interest rates are raised by the Federal Reserve and Chair Kevin Warsh, it will be because spiking oil prices have increased inflation risks.
There are a few things more important to look out for than interest rates when the Federal Open Market Committee announces its next decision on Wednesday, according to a BlackRock strategist.
"The key question for investors isn't Wednesday's hike," Gargi Pal Chaudhuri, global chief investment and portfolio strategist at the asset management firm, told MarketWatch. "It's whether higher oil prices have fundamentally changed the Fed's reaction function."
Markets are currently pricing in a 93% probability of the Federal Reserve raising rates by 25 basis points to at 2 p.m. Eastern. Then at 2.30 p.m., Fed Chair Kevin Warsh will hold a press conference - which for Chaudhuri could prove to be more significant than the decision itself.
"We will watch oil, core PCE [personal consumption expenditures] that has some upcoming methodology changes that will provide some downward pressure, as well as Chair Warsh's explanation of what would trigger another hike," she said. "Those signals matter far more than the 25 basis points itself."
It comes as oil prices have again spiked, with both West Texas Intermediate (CL00) and Brent crude (BRN00) remaining stubbornly above the $100 a barrel mark, driven by escalating tensions in the Middle East. The U.S. benchmark is up 22% since the start of the month and the international benchmark is up 19% in the same period, stoking fears of prolonged heightened inflation.
For Chaudhuri, despite market expectations, the Fed should be holding rates, maintaining a level between 3.50% to 3.75% because inflation is actually moderating. While the U.S. core consumer price index rose by 0.3% month-on-month in August, overall, the 12-month rate stands at 2.4%, down from 3.1% last year.
"They aren't hiking because inflation is spiraling higher or inflation expectations are becoming un-anchored," she said. "They are hiking because oil has increased upside inflation risks and because policymakers want to demonstrate they remain committed to price stability."
Chaudhuri recommends that investors stay invested but to diversify their portfolios. BlackRock still likes artificial-intelligence companies, especially those focused on infrastructure and showing signs of monetization. The firm favors the iShares AI Innovation and Tech Active BAI, the iShares Nasdaq 100 IQQ and the iShares Semiconductor SOXX exchange-traded funds.
She then advises broadening into themes like quality, such as the iShares Edge MSCI USA Quality Factor ETF QUAL, dividend growers, including the iShares Core High Dividend HDV, and healthcare.
"If investors are looking outside the United States, we would favor emerging markets over developed international markets and particularly Asia," Chaudhuri said, suggesting Taiwan and South Korea for their critical role in the AI supply chain, and China, India and Japan for alternative sources of economic and earnings exposure.
"Higher rates make income more attractive in portfolios, and we think investors should focus on using these income levels to add to income sources in the front end and belly of the curve with products like BINC [iShares Flexible Income Active ETF] BINC," she said.
Chaudhuri also said investors should really be looking at the weight of assets in their portfolios, as the traditional 60/40 model assumes that stocks and bonds react differently to economic changes, but recently, they've both been responding the same way to AI capital expenditure, inflation, fiscal issuance and long-term interest rates.
Instead, she suggests incorporating an alternative returns source like the iShares Systematic Alternatives Active ETF IALT.
"Our portfolio message would be: own growth, own income and own something that behaves differently," Chaudhuri said.
-Nora Redmond