Investors are running scared and bond markets are crashing, as hopes for a pivot from the Federal Reserve evaporate and the amount of easing next year priced into the U.S. interest rates futures curve shrinks to less than 25 basis points.
The Fed is undertaking its most aggressive policy tightening campaign in 40 years and after months of pushing back, investors have thrown in the towel: everything they do now - mostly selling - is anchored in the mantra 'don't fight the Fed'.
Bearing in mind that the Fed's inflation target is 2.0%, this suggests that the real rate of interest - r-star , the nebulous, inflation-adjusted interest rate that neither fuels nor curbs growth - is also unchanged at 0.5%.Intuitively, this is surprising.
Joe Lavorgna, managing director at SMBC Nikko Securities and a former White House economic advisor, is one of the few analysts who thinks the Fed will be forced to U-turn next year due to the economic damage the historic tightening will wreak. Markets are anticipating around 60 bps of easing between March 2023 and December 2024, the least since June and almost half of what was priced in only a few weeks ago.The Fed's policy target rate is now 3.00%-3.25%, the highest since 2008, and the Fed's latest projections show it rising to the 4.25%-4.50% range by the end of this year and ending 2023 at 4.50%-4.75%.
But others argue that there are structural shifts underway that will keep inflationary pressures higher than before, meaning the neutral rate should also be higher. They include slowing global trade, onshoring, higher energy costs, and the costs involved in fighting climate change.
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