MacroResearchBoard

Be Careful What You Wish For – December 16, 2019

One constant that has provided support under risk asset markets has been the strong belief that inflation is dead, and therefore bond yields cannot rise much further, and the Fed and other central banks are on permanent hold. In fact, the U.S. forward markets are priced for lower rates in a year’s time. MRB has a different view.

We recently examined the prospects for U.S. monetary policy in 2020 and beyond, and concluded that the next move will be a rate hike, not a cut, albeit perhaps not until 2021 because of the political heat from President Trump and a contentious election cycle next year. The Fed recently has been clear that it wants core inflation to rise sustainably above its 2% target.

The Fed is on track to get its wish, given the upbeat trend in hiring plans and wage compensation. Already, median measures of core inflation are in steady uptrends, and we anticipate that the Fed’s favored measure of inflation (the core PCE inflation rate) is on track to clear 2% next year. The implication is that the Treasury market and the Fed are setting up for a reassessment of the inflation and policy rate outlook within the next 6-12 months, which will catch investors off guard.