Playing chicken with the Fed
“Markets finally appear to be backing down in their longrunning game of chicken with the Federal Reserve,” says Eric Wallerstein in The Wall Street Journal. Global markets have rallied in recent months on bets that slowing inflation “would prod the central bank to begin cutting interest rates later this year”. Now they are having second thoughts. Last month US retail sales grew at the fastest pace in nearly two years, while consumer price inflation fell less than expected. That means the “pivot” in interest rates isn’t coming soon.
At the start of February, futures markets were pricing in two US interest-rate cuts before the end of 2023, says Kate Duguid in the Financial
Times. Now they suggest “roughly equal chances of one rate cut or none”. Markets expect US interest rates to peak at 5.25% this year; rates are currently between 4.5% and 4.75%. They are also more concerned about persistent inflation. The one-year breakeven measure – where investors believe inflation will be in a year’s time – has risen from 2.1% to 2.9%.
Investors have spent months debating whether the US economy is heading for a soft landing, where inflation is brought under control without much economic damage, or a more painful hard landing, says Teresa Rivas in Barron’s. Yet the strength of recent economic data has raised the prospect of “no landing”, a scenario where the economy keeps growing, but inflation refuses to be tamed. That’s bad news for the stockmarket. “No landing means no Fed pausing,” says Michael Hartnett of Bank of America.
If inflation stays elevated, then the Fed will conclude that “the only way to bring inflation down is by causing a recession”, says Ed Yardeni of Yardeni Research. “The inflationary no-landing scenario may turn out to be the long way to a hard landing.”