In a recent report, UBS Group AG strategists have cautioned that the chances of the Federal Reserve hiking interest rates, instead of cutting them, are on the rise due to strong US economic growth and persistent inflation. This scenario could lead to borrowing costs reaching as high as 6.5% next year.

While UBS's initial prediction was for two interest rate cuts in 2021, they now see an increasing possibility that inflation will fail to decline to the levels targeted by the Federal Reserve. This could trigger a shift in policy back to rate hikes, potentially causing a significant downturn in both bond and stock markets.

Investors have already scaled back their expectations of policy easing as recent data from the US has revealed unexpectedly robust performance in the world's largest economy. The combination of strong economic growth and stubborn inflation has raised concerns about the effectiveness of rate cuts in stimulating the desired level of inflation.

If the Federal Reserve decides to raise interest rates, it is projected to result in a substantial selloff in both bonds and stocks. UBS Group AG strategists warn that such a move could cause Treasury yields to flatten and knock off between 10% to 15% from equity markets. This outlook highlights the potential impact of a policy shift on financial markets and investors' portfolios.

The report emphasizes the need for investors to closely monitor inflation trends and the Federal Reserve's stance on interest rates. Any indication that inflation remains persistently high could potentially prompt a change in monetary policy, bringing about higher borrowing costs and affecting investment decisions across various sectors.

Overall, UBS Group AG's strategists are urging caution and proactive monitoring of the evolving economic landscape. While their base case still predicts rate cuts this year, the growing possibility of inflation remaining sticky raises concerns of a potential pivot back to hikes, which could carry significant ramifications for the broader financial markets.