BlackRock says it's time to 'shun most stocks' with markets underestimating the risk of a Fed-induced recession

• Investors should avoid most stocks with recession risks rising, according to BlackRock.
• The Fed and other central banks have underestimated the severity of the recession that their rate hikes could trigger, the asset manager said.

Investors should look to avoid most stocks with recession risks rising, according to BlackRock.

The $10 trillion asset manager has warned that the Federal Reserve and other central banks have underestimated the severity of the recession that their rate hikes could trigger.

"Many central banks aren't acknowledging the extent of recession needed to rapidly reduce inflation," a team led by BlackRock Investment Institute head Jean Boivin said in a recent research note. "Markets haven't priced that so we shun most stocks."

The Fed hiked interest rates by 75 basis points for the third time in a row last week. Its tightening campaign has weighed significantly on stocks, with the benchmark S&P 500 falling 7% since August's hotter-than-expected inflation data suggested the Fed would have to carry on hiking to bring soaring prices under control.

The US central bank also indicated last week that it will raise interest rates as high as 4.6% by the end of next year, while Chairman Jerome Powell acknowledged that there's a "very high likelihood" the US faces a period of below-trend growth.

But Boivin's team said that the Fed's cheerful economic projections overestimate the likelihood of a soft landing. In that scenario, the Fed successfully cools inflation with interest rate hikes while avoiding a severe downturn.

"The Fed still sees positive growth this year and sees it picking up next year," the BlackRock strategists said. "But it also wants to see evidence core inflation is on a decisive 2% trajectory beyond 2023 before it stops hiking."

"This soft landing doesn't add up to us," Boivin's team said.

The Fed wasn't the only central bank to raise interest rates last week, with the Bank of England implementing a 50-basis-point hike and Sweden's Riksbank announcing a supersized 100-basis-point hike.

The global "rate-hike blitz" suggests that other central bankers share the Fed's optimistic outlook, according to Boivin's team. BlackRock warned that aggressive overtightening could trigger a downturn before inflation has cooled sufficiently, leaving central banks torn between raising and slashing rates.

"Many central banks, like the Fed, are still solely focused on pressure to quickly get core inflation back to 2% without fully acknowledging how much economic pain it will take in a world shaped by production constraints," Boivin's team said. "Case in point: last week's rate-hike blitz."

"This all implies a clear sequence: overtighten policy first, significant economic damage second and then signs of inflation easing only many months later," the strategists added.

Read more: BlackRock says markets will get 'Fed up' with too much tightening as growth slows, with Powell showing the most resolve since Paul Volcker