Everyone expects the next Fed chair to be extremely dovish, which is setting up the entire market and economy for a massive disappointment
If the Fed cuts rates into accelerating inflation prints, it will create a significant risk for markets and the underlying economy 🧵🧵
While financial news only focuses on the 1st order effects of the Fed and the economy, the market is ALWAYS pricing the full distribution of 2nd and 3rd order effects.
This is why 1 year inflation swaps are at 2021 levels. They are pricing the risk of higher inflation and indicating that the Fed's stance is too accommodative.
And this is not just in durable goods from the "tariff inflation", it is services inflation consolidating in a range. The chart below is PCE services inflation. The fact that the Fed is allowing rate cuts to be priced into this is consolidation is WHY inflation risk exists.
This is the guiding principle for HOW to think about this environment: If we get a super dovish Fed chair, then they will have to actively acknowledge that their dovish actions will increase the probability of inflation and thereby long-end rates blowing out.
Full article:
The media personalities and politicians are just talking their book so they can succeed in their domain, even if it's at the expense of the people they serve. Markets will always price the risks of both nominal and real changes regardless of how many policy errors the Fed makes.
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