I’ve been wrestling with the theory that we have had a regime change from the credit dislocation cycles that have led to emergency-type measures from the Fed via balance sheet expansion and near 0% interest rates to one that has inflation as much more of a central concern due to powerful fiscal expansionary tendencies and other factors such as onshoring of manufacturing,
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Just when the market prices in four cuts for 2024, either the Fed comes out to talk the market down or data is released to suggest investors are being too aggressive in pricing in the number of Fed cuts.
We are now back to the point where the market and Fed are once again aligned on the number of cuts in 2024.
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There are things you can replace
And others you cannot
The time has come to weigh those things
This space is gettin’ hot
You know this space is gettin’
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Last week, the GDP report for the 4th quarter was released as well as the Fed’s favorite inflation index, the Personal Consumption Expenditures price index (PCE). The Fed should be very pleased with what the reports revealed and how it has defied the overwhelming consensus that a hard landing was necessary to break the back of inflation.
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Perhaps Powell’s pivot was highly influenced by having access to the Fed’s favorite inflation indicator, the Personal Consumption Expenditure Index (PCE), well ahead of its official release last Friday. As this headline from the Wall Street Journal shows, the index went into negative territory,
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Powell did it for the third time. He proved for the third time that you should listen to him carefully until he does something completely different, and then you should listen to him again. After raising rates aggressively starting in April 2022, after he had said that the Fed wouldn’t raise rates until the end of 2023 at the earliest,
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Last week may have finally been the week when the Fed aligned with markets that the peak in rates may be in for this cycle. The Fed held rates in what was initially categorized as a “hawkish pause.” It was during the Jay Powell press conference that the market started to believe that maybe the Fed was done raising rates.
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I was definitely in the camp that once the yield curve inverted, we were headed for a recession within a year or so. The spread between the 10-year Treasury and 2-year Treasury yields went negative (inverted) in early July 2022.
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I must say that when I read this tweet last week, I felt heard, listened to, and understood. It was cathartic in a way.
I know I’m being a bit melodramatic, but there are so many cross-currents in the economy that it has made forecasting quite challenging.
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I have written continuously over the last year or so about critical yields for the 10 and 2-year Treasuries such that if they were breached, the probability of them going higher would be quite elevated.
Looking at the following 10-year Treasury chart,
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