Don't fight the Fed? Or the Fed is clueless?
The Fed said inflation was transitory. So should we now believe its hiking story?
Dear readers,
Markets (and yields, specifically) are heating up now that school is back in session and trading desks will be fully staffed post Labor Day. September is an important month—all of our recent hypotheses about the Fed and markets will be tested over the next three weeks. Tonight, we take a look at the most important charts, as key levels are being breached and tested this Wednesday evening.
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Today’s topics
The Fed and Jerome Powell have put it all on the line. We believe they are only slightly bluffing on tighter monetary policy. Restrictive for longer, sure, but how restrictive?
The relationship between 2-year yields and Fed Funds.
If 10s retest 3.50%, risk markets are going to get ugly.
A curious and important divergence between 2s and risk assets.
Stocks and bitcoin charts suggest we are in a danger zone.
Don’t fight the Fed
You’ve heard the saying. But why do people say it? Because when the Fed is determined to ease, risk markets love it. And when it is slamming its foot on the brakes, markets hate it. We saw this play out in 2022, with monetary tightening leading to a terrible performance across all interest-rate sensitive asset classes (which is to say, all asset classes). Only now, we are getting to the point when I stop accepting the Fed’s word at face value.
Think back to 2021. The Fed repeatedly said that inflation was transitory due to supply chain disruptions caused by the pandemic. The cause is still up for debate, but the word “transitory” is not. Powell admitted this in his Jackson Hole speech, but now he is saying something else: rates will continue to increase, as well as stay restrictive for an extended period of time to bring inflation down.
What does this mean for policy rates if we believe Powell at each stage? If we believed his transitory spiel, we would have bet on Fed Funds rising to 2% over a year’s time, not 3% in six months. If we believe him now, Fed Funds are heading to 4% (or beyond) and remaining there for a year. I’m calling bullshit on that one. I’ll explain why, starting with Bloomberg’s implied Fed Funds curve.