US Macro2Markets Outlook: Lags are Such a Drag

Monetary policy transmission is not broken, it's just waiting to kick into gear

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Latest Views
We maintain that a soft landing is unlikely (it’s going to get bumpy ahead) and recent gains in stocks/credit market was just a bear market rally. The economy will likely either enter into a midcycle slowdown or fall into a mild recession (à la 2001 style). For now, external factors, which is a very long list (weak global trade, nonstop China headlines, liquidity/USD FX implications etc) haven’t directly impacted US activity. Meanwhile, loose fiscal policy is delaying the full effect of the Fed’s super tight monetary policy stance. We also believe the lags are inordinately longer this time. Yet we still hold the view that Fed policy will kick into high gear the longer rates stay elevated.

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U.S. Rates Forecast
We now see the Fed staying on hold for the balance of the year. Moreover, we have also pushed back our first cut into 1Q24. Moving from “how high” the Fed Funds rate goes to “how long” can the Fed stay on hold, this may end up being harder to achieve if something breaks and/or the data turns. With all tenors of the curve still under the level of Fed Funds, ironically the longer the Fed stays on hold, the belly/intermediate rates are the most at risk of normalizing higher. Bear steepeners are also aided by issuance fears.

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