Asset markets aren't prepared for a hawkish Fed. As Bloomberg's Richard Breslow notes Fed speakers have even taken to the Sunday talk shows to beat the rate-rise drum as economics is morphing into punditry. They’re going to raise rates because they can, are independent, apolitical and can’t be bullied by foreigners. The numbers notwithstanding…
Hallelujah
Perhaps we’ll know more when Chair Janet Yellen speaks on Friday in the more rarefied surroundings of Radcliffe Yard. For all the talk, one thing is true: asset markets aren’t priced for a FOMC ready to raise rates and looking to do more.
The yield curve continues to flatten, reaching its tightest levels since 2007. That’s a sign of low medium-term inflation expectations and concern that the economic cycle is closer to recession than boom.
It also reflects investors continuing to extend duration in search for yield, exactly what the Fed has forced them to do.
Simply put, as BofAML warns, a lack of credibility constrains Fed effectiveness drastically as they have "cried hawk" one too many times…
The policy mistake angle assigned to the Fed is visible in more areas than the yield curve.
As we have said repeatedly stated before, the TIPS market continues to believe that the Fed will deliver real rates that are far too high and miss on its long-term inflation target by at least 50bp.
To us, the lack of focus and the inability of the Fed to improve longerterm expectations priced-in to the rates market the line of igniting a bigger concern: getting dangerously close to the market pricing in inverted yield curves, two to three years forward.
The policy mistake feedback loop in the rates market will unwind only when the focus shifts to boosting longer-term global growth and inflation expectations as opposed to shifting near-term hike probabilities in an environment where structural risks remain (China, potential growth).
Therefore, as Breslow concludes, if the Fed plans to preemptively tighten, many investors will be caught massively off side doing the central bank’s bidding. Unless the Fed immediately starts intoning the mantra of “gradualism” in every speech.
Which raises the question, “why tighten now?” Inflation below target, but too many jobs being created seems an odd rationale after so many lean years.
With equities still hovering near all-time highs despite earnings being suspect, and global trade under attack, it’s hard to argue anything priced in.
What cost are they prepared to pay to give banks better net-interest-margins?
The dollar has been bouncing in the last three weeks from silly levels and amid further global economic weakness. A hawkish Fed could see the rally pick up a head of steam.
Dollar strength protesting as game theory: Get it low so it can go up from a lower level.
If the Fed wants to rack up a success, they should let the economy continue to improve. Raising rates when they aren’t sure risks being a “Mission Accomplished” moment.
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