Jerome Powell is pretending that he can raise interest rates above the inflation rate. Real yields are still negative. Why? Powell & Company fear raising the target rate above the inflation rate because they know a financial crisis would be triggered and the US economic house of cards would fall! Thus, the Powell Pivot has already occurred. We’re only waiting for the markets to comprehend and confirm the fact.
The US industrial base and asset values are not a house of cards.
The issue is getting well into 2024 as the IRA is ramping up. We will be exporting manufactured goods as a deflationary economic force. China is no longer doing that.
@NewLiberal the market actually believes that inflation will recede to 2.54% within 5 years and even less after that. The Fed is trying to raise the fed funds rate fast enough to tamp down inflation but is hoping for a soft landing (no recession or mild recession).
I agree with you that the historical norm of keeping the fed funds rate about 2% above the inflation rate would cause massive disruption in the U.S. economy. The Fed has suppressed interest rates since 2000 and the economy is addicted to the crack cocaine of negative real yields.
But I don’t see a “Powell Pivot” yet. What exactly do you mean by a “Powell Pivot”? Powell has been clear that the Fed will raise the fed funds rate and hold it at an elevated level for an extended period of time. Powell knows just as well as you do that the real fed funds rate is still negative. He’s counting on inflation falling so the real fed funds rate will be positive.
I don’t think that would cause a full-blown financial crisis although it would cause a recession and some companies would fail. That’s not enough to stop the Fed’s plan.
If you don’t believe that inflation will fall as low as the market believes (I don’t) then the bonds to buy are TIPS, not fixed-rate bonds.
Wendy
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That depends on if the FED is anticipating inflation two to three years out looking over the horizon after inflation comes down. Higher rates offer to break inflation longer term than running down the FF rate to reload which incidentally reloads the inflation. Fiscal policy can drive growth even with higher rates.
Those expectations can be seen in the yield curve. For example, the reason the 10-year rate is lower than short term rates is that inflation is expected to be lower 10 years from now.
Adjusted for inflation, the yield curve is not inverted.
DB2
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Cool got ya!!!
But that is not how it works. Yes that is one way of seeing the spot market.
The bond market is more volatile than the equity markets. - CFA materials.
In other words it does not have to work out that way. When rates come down inflation is uncorked again. That is not currently priced into the spot market.
Rates probably wont come down much not with counter cyclical economics.