Policy error chart pack and global macro update: the Fed has murdered the economy
Fed hikes by 75 basis points again in what might be the last tightening of the cycle. Policy error, embodied.
Greetings from Chicago after a lovely half-week of Canadian hospitality in Toronto!
Whether or not they like it, Federal Reserve voting members have officially pushed monetary policy into restrictive territory. This is not an opinion, rather a snapshot of the rates market. Today’s post is a breakdown of the global macro situation, some price study, and my outlook on asset prices. Excited to bring you an update to my latest narrative switch—the worst of the tightening is over, and risk markets are breathing a sigh of relief.
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The last rate hike?
I’ve never followed economist expectations, especially those from the Fed. Instead, I watch rates. I watch Treasury bills, notes, and bonds. I watch the Eurodollar futures market. I watch Fed Fund futures, more specifically the OIS (Fed Funds derivatives) market. Using the array of interest rates on my watchlist, it’s not that I am able to predict the future, but I truly believe that the internals of these markets tell us what the Fed is going to do months before it actually happens.
Rewind to late last year. Inflation had started to pick up, and the front end of the yield curve (all money market rates and all the way out to US Treasury 5-year yields) told us that an aggressive rate hiking cycle was about to begin. And it bordered on insane, the eventual pace of tightening. In a period in which the Fed raised rates by 150 basis points, including the first true indication that hikes were coming which happened a couple months before the first hike, 2-year yields went from 0.5% to 3.5%. Pause to think about that for a second.
The Fed indicates a hiking cycle, and the front end of the curve does all the work. 3% of work. This move by itself completely slammed the real estate market (pending home sales now down 20% year-over-year).
Now, bring yourself to June 15th. The Fed leaked a 75 basis point hike (versus the expected 50 basis points) with less than 48 hours until the FOMC meeting, and the market had its ultimate inflation freak out. Treasury yields moved up to 3.5%.
What are the dueling narratives today?
The freak out narrative sounds like this: inflation is at 40-year highs, and we have entered a 1970s style inflation that can only be subdued with sky-high interest rates. The inflation was certainly caused by copious amounts of fiscal and monetary stimulus. The Fed will need to hike rates well above 3% to tame inflation, and it might not be able to lower it with rates at 3%.
The rates market narrative (with which I agree) goes like this: inflation is the result of a pandemic-induced supply shock, and even though copious amounts of fiscal and monetary stimulus no doubt have contributed to the explosion in inflation, disinflation will resume before the end of this year. The Fed has hiked enough, and its job of bringing down forward inflation expectations has already worked.