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Friday, May 27, 2022

Real rates warn of the need for greater urgency from the Fed

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(Bloomberg) — The Federal Reserve’s most recent dot plot shows seven rate hikes this year, more than double the amount the monetary authority forecast in December would be needed to rein in inflation. We have seen a procession of Fed spokespersons, including the more dovish members, saying that they must get down to business as soon as possible.

And what did we get from the markets? Nominal yields have reacted with force and conviction. But to appreciate the real reaction, take a look at the real rates. In the week since the Fed met, the yield on five-year instruments has fallen, and has been much lower than this year’s high. The 10-year bond yield tells a similar story.

It is as if traders are shouting loudly at the Fed, saying that its actions have not pressured their confidence that inflation is likely to be brought under control anytime soon. While its chairman, Jerome Powell, picked up some anti-inflation rhetoric earlier this week, he did not send a strong message that the monetary authority would raise rates by 50 basis points in May. Instead, he phrased his message in equivocal conditionality: “if necessary.”

The Fed under Powell has earned a reputation for signaling what it plans to do ahead of time (whether that is desirable is another matter), but this message did not. The last thing markets need in this context is subjectivity. And, in any case, what does “if necessary” mean in the context of an inflation that is already devastating everyone’s pockets?

Next, there is concern about whether the Fed can maneuver a soft landing. For the Fed to have any chance of achieving this goal, it must move earlier in the business cycle, not later. The longer you wait, the further behind the curve you get, and the worse the problem becomes. The Fed has a lot going for it now unemployment: ultra-low and above-trend growth; In other words, the economy is probably more prepared to withstand a path of steep rates than it has been in a long time. And we do not pretend that there will be no price to pay for having fueled inflation through 2021 and 2022 by ramping up bond purchases and trying to make up for lost time now. Far from it. We will have to pay a precious, but the sooner it happens in the cycle, the better.

original note:

Real rates need more urgency from Powell and the Fed

Come Ram is a cross-asset strategy for Bloomberg’s Markets Live. The remarks are my own and are not intended to be investment advice.

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