How long can Fed hold interest rates down?
Abraham George Macro View
The inflation data that was released yesterday was slightly higher than street expectations meaning it was hotter. In a world where most of the seasoned Fed watchers and bond traders believe that the Fed is behind the curve on inflation already, the reaction from the markets was rather surprising. The treasury market moved in the opposite direction of what would otherwise be an intuitive trade to be short bonds.
So what’s happening? There are many who still believe that one should never fight the Fed. In the grand scheme of things probably that is still true. The decades long structural low inflation environment is still intact. That’s the belief many participants still hold in the markets. In the words of Fed Chairman Jay Powell, the interest rate environment wont ‘change on a dime’.
The 10 year yield sliding down to 1.45% probably strengthens the belief of the bond holders and is also swaying the minds of the fence sitters in favour of holding bonds. The truth of the matter is the Fed is very clearly manipulating the interest rate market. This is no secret. We are faced with an economy that is accelerating at nearly double digit growth pace, house prices rising to record highs, an inflation rate as high as the worst you have seen in 30 years, Chinese input prices rising by three fold from last Mar. How is that the ten year yield cannot close above 1.55%? The Fed clearly has its foot on the pedal. They are still buying more than $80 bio treasuries every month. Is it that the technological advancement is aiding the deflationary story?. While it has its benefits the Fed is the real culprit.
How long can the Fed play this game? The structural environment is changing quickly through an unprecedented rise in money supply, a massive and a broad based rise in wages. The more the Fed holds this down the bigger the explosion and damage inflation will do to the upside.
Abraham George is a seasoned investment manager with more than 40 years of experience in trading & investment and portfolio management spanning diverse environments like banks (HSBC, ADCB), sovereign wealth fund (ADIA), a royal family office and a hedge fund.