In our view, the Fed’s “higher for longer” (HFL) view is inconsistent with a soft landing as a) it ignores the long and variable lags of tightening, b) it suggests higher restrictive rates will not impact the economy (why hike then?), and c) it assumes they’ll slow walk cuts (historically they cut fast when facts change).
The HFL stance also has a number of embedded conditions that need to be held constant in order for the Fed to maintain rates at restrictive levels (and still achieve a goldilocks scenario). Such conditions are: the jobs market will remain tight for the foreseeable future, there won’t be any major financial accidents in the future, and global uncertainty does not worsen from here.
Yes, we understand that the immediate focus remains getting inflation close to target, but the focus can, and likely will flip to growth concerns. If the Fed waits for a signal to cut, sadly it might come too late. The HFL premise turns into a paradox if they don’t proactively lower rates. In other words, waiting for undeniable proof, while keeping rates high, increases recession odds.
Our framework has been built upon, contrary to some narratives, the novel notion that high rate levels matter for a leveraged economy. So long as L/T rates stay where they are (or higher) in the 5yr+ sector, interest rate sensitive sectors like autos and housing will start to impact US growth. And if L/T rates maintain a positive term premium too (due to deficits/large supply), the UST market will crowd out credit and compete with equity markets as well.
In order for us to change our bearish views, we would need the Fed to cut soon (low chance), bold and coordinated easing efforts from China (a big maybe), and a peaceful end to ongoing wars (sadly this seem unrealistic at this point). However, this idea that the US is an island and can maintain sustainable organic growth with high debt loads & high rates is not probable
• US Inflation Measures: Getting to the (Super) Core of it
• The State of Housing: Impact of High Rates & Home Prices
Market Views & U.S. Rates Forecast
We had an out of consensus call mid-summer that the bear steepener would both tighten for the Fed and reveal that the mid-year risk rally was just the 1st (of many ahead) counter-trend bear market rallies (with SP500 slicing thru 4200 vs staying above 4600). In our opinion, the Fed is done hiking and will cut in 2024. Yet, US rate markets are unlikely to see a big rally until jobs data rolls and/or something big breaks in markets.