• Posted on March 28, 2024 by MI2 Research

“An operating environment that is particularly fluid”

Now a week out from the Fed making it clear that the squeeze of lower growth isn’t worth the juice of bringing inflation back to (not toward, Jerry!) 2%, Mohamed El-Erian summed up the state of play nicely in a recent article for the FT. The Queens’ College president noted that,

“It is not often that you see a reputable central bank revise up its inflation and growth projections and yet strengthen a dovish tilt to its policy stance. Yet that is what happened in Washington last week when the Federal Reserve raised those projections up a notch and yet delivered two consequential signals – a willingness to tolerate higher inflation for longer and an openness to slow the ongoing reduction in its balance sheet.”


Jim Bianco summarized the Fed’s “signal” succinctly, saying “inflation expectations are becoming unanchored.” Waller pushed back on this idea in his latest speech, saying that he continues to believe “that further progress will make it appropriate for the FOMC to begin reducing the target range for the federal funds rate this year. But until progress materializes, I am not ready to take that step.” Are Waller’s comments a hint that there may be a limit to the Fed’s shamelessness? Or is it that the potential risks associated with “unanchored expectations” are becoming clearer? Perhaps, but Bond markets have yet to really call the Fed’s bluff. Breakevens are continuing to be range-bound (though its goofy, sometimes-inflation-sensitive cousin, gold, is screaming higher). Long-end yields have not traded well, but they haven’t been unequivocally bad either, and with equities continuing on their merry way, why worry? There is, of course, a chance that financial conditions may be looser than the Fed thinks. However, we might have to wait for Mr. Powell’s next speech to find out whether he still thinks rate cuts are appropriate. Is 3% inflation the new 2%?

Rate cutting certainly does seem to be in the air. As we noted last week, the Swiss cut by 25bps, and there have been mutterings in both London and Frankfurt that could be taken for a hankering to lower rates. One could make the case that the dumpster fire in commercial real estate might justify lower rates. But what if the evident problems in US CRE are somehow contained? What happens in Vegas stays in Vegas, and the same for Dallas, Boston, and San Fransisco? We’ll be watching the bond market to see if someone eventually decides enough is enough, and with a significant amount of duration set to hit the market, finding a clearing price may be a bumpy road.


P.S. El-Erian is of the belief that economic conditions “will not easily allow inflation to quickly fall back to 2 per cent and stay there without unnecessary damage to economic wellbeing and financial stability” Bye-bye 2% target? Yes, but mum’s the word!