MacroResearchBoard

Front-Running Policy Rate Cuts Is Self-Undermining – August 19, 2024

A just-published report reiterated our mildly pro-growth investment stance. We remain more upbeat on the global economic outlook than the consensus (and some days it feels like we are way more upbeat!), expecting solid growth ahead with sticky DM inflation.

One unique feature of this decade’s rate-hiking cycle has been the persistent and increasingly aggressive front-running of the next rate-cutting cycle. For instance, even in the face of the stellar performance of the U.S. economy, the gap between 2-year Treasury yields and the fed funds rate is as negative as it has ever been, on a par with the extremes in 2008 when the U.S. banking system and economy were in freefall.

Previous gap extremes have slightly led the start of recessions, but investors could clearly see that economic conditions were already deteriorating, corporate profits were under assault and financial markets were under far more pressure than what occurred this month.

Ironically, expectations for much lower policy rates in the next year helps to prolong the U.S. and global economic expansion, thereby putting a floor under DM inflation. In other words, it is bond bearish!