For the last several months (since Jackson Hole) markets haven't been sure how quickly inflation would come down and therefore how high the Fed might risk taking rates. But today we have much more certainty. We now know the Fed really can't raise rates much more near-term given the risks and longer-term the stimulus and supply bottlenecks which created the majority of the inflationary pressures will ease.
Another thing you need to remember is that inflation easing is actually deflationary because real yields are calculated by nominal yields minus inflation. So as inflation comes down you're actually getting paid more to lock your cash up in bonds which continues to tighten financial conditions.
The risk of a larger financial crisis is very low given this isn't a credit event, but a duration event. As long as the Fed doesn't raise rates further we can rule out a financial crisis and so long as you don't believe there is a structural inflationary problem in the economy rates should trend downwards over the coming months.
It's not really supply chain bottlenecks. It's greed. Same thing for "14 year olds can work in meat packing plants".
Greed is having a moment and must be countered by policy (top marginal tax rate of 90%, let's go!)
Inflation was kept low through the 2000s despite massive quantitative easing because you had the entry of 3 billion workers into the global economy, keeping wages low even though the money supply was high. That trend has reversed. China hit peak workforce employment in 2015 and their workforce is now shrinking fast, the result of their One Child Only policy in the 70s. The same demographic headwinds affect all major developed economies. Fertility rates fell below replacement rate in most of the developed world in the 1990s - that baby bust is now entering the workforce.
Similarly, technological progress has slowed down over the last 40 years. Much of the low-hanging fruit has already been picked; only a select few industries still show significant technological development. In particular, the major need-to-live industries like housing, health care, food, and energy have seen few yield-increasing technological developments over this period, and their price has risen accordingly.
We don't understand the drivers of inflation very well and people have different theories on this.
You may be correct though. Fundamentally inflation is driven by the change in the supply and demand for goods and services, and in a globalised world with rapidly changing geopolitical landscapes and technological advancements it's hard to predict actually how supply and demand pressures will balance out in the coming years.
However, what we do know is that demographics have historically correlated well with inflationary pressures. The inflation in the 70s was likely in part driven by the huge growth in demand which came from the baby boomers entering the economy. Then more recently you have examples like Japan where demographics have clearly played a role in their sluggish economic growth and low inflation.
But to be clear, I'm not saying the market is necessarily right in its pricing, I'm just suggesting that there's a lot of good reasons to believe the Fed funds rate is currently too high and will need to come down. Even if you're correct you would still have to explain why inflation rocketed up in 2021 right after trillions of dollars of stimulus entered the economy. The trends you're describing have been in place for years. The inflation we've seen over the last couple of years in my opinion is just far easier to explain via the combination of reckless monetary policy, fiscal stimulus and lockdown policies.
That's the thing, you can't know that. Rates could go up, down, sideways, or in circles over the next 10 years. A 10-year bond locks it in to a predictable rate and payment schedule.
The world does work that way! Most people don't want bad stuff to happen, and will take action, coordinated or otherwise, to prevent bad stuff from happening.
To me, sounds like the Fed is trying to slow this thing down without spooking people. So, promise to cut rates soon, then see what people can actually tolerate, and maybe leave them high enough to chafe a bit.
I'm not saying this is proof that they won't hike rates, just that what they say should be heavily discounted.
They might just pivot on a dime.
What I find interesting is that literally everyone is saying that FED is wrong.
Like find me anyone outside FED that says: yeah, rising rates is good.
Granted, many people who comment (wall street) have self-interest in rates being low but I don't think there's any notable economist who isn't critical of FED.
High interest is killing stock market returns.
No administration wants to enter election season with decimated stock market.
Hence, if nothing else, there will be political pressure on FED to lower interest rates to juice up stock market.
Second, some kind of recession is expected by many so if it happens, that will a reason to cut rates.
The fed historically does take actions adverse to employment in election years.
https://www.advisorperspectives.com/commentaries/2016/08/25/...
The stock market (as measured by SP500) is down only 15% from its all time high, and is currently higher than any point before 2021.
Inflation, however, will reliably kill a presidency. Note that we went through 4 presidents in the 8 years of the 1970s inflation, while the average president in the 40 years afterward served for 8 years. This holds universally across cultures as well - globally, countries like Venezuela, Zimbabwe, Weimar Germany, post-war Eastern Europe, etc. go through rapid regime change during periods of high inflation.
[1] https://www.pewresearch.org/fact-tank/2020/09/25/few-in-u-s-...
Hard to say the Fed won’t cut rates when their own projections have them cutting rates.
SVB didn't do anything to hedge its duration even well after the "inflation is transitory" period was over.
The Fed has been very explicit that they need to tighten labor market conditions. "Tighten labor market conditions" = "cause layoffs". That's how it works, they just can't say it out loud because it'll spook people. They can't bring down inflation until they raise rates high enough that companies start going under, and they have no incentive to lower rates unless actual bad things are happening in the real economy. (Remember also that when rates are high, the Fed has more room to cut when actual bad things do happen, because there's a floor at zero.)
The logic behind this seems a bit circular to me. Market participants accept lower long-term bond rates because they expect the Fed to cut rates in the future. They expect the Fed to cut rates because if they don't, there will be a financial crisis. There will be a financial crisis because long-term bond rates are high and banks are underwater on their bonds, except that bond rates are declining because the Fed is going to cut rates, because...uh, why is there going to be a financial crisis again? What reason does the Fed have for dropping rates? It's very much an "appeal to consequences" fallacy - some bad outcome is not going to happen because that would be bad. The world doesn't work that way.
IMHO the market is wrong, and the Fed is not going to cut rates. They've gotten too accustomed to being bailed out, and the Fed is on to them, and so they're not going to do that again, at least not in the form that the market expects.