Healthy Labor Market, Inflation Approaching 2%: Is the Fed’s Job Done?
Macro investing without deeply understanding bond markets is like eating soup with a fork.
You can still somehow make it, but it’s cumbersome and unproductive.
We are at a crucial juncture for macro and monetary policy, which means getting a grip on bond markets is even more important.
This piece will help you with that, and most importantly provide you with the right framework to use.
Everyone is talking about this chart all the time:
Market Implied Fed Cuts/Hikes
It shows the market-implied Fed cuts (in bps) over the next 12 months, and it says -165 bps.
165 bps of cuts in 12 months is quite aggressive by historical standards.
Even in early 2008 with Fed Funds at 4.50% and the US economy on the verge of a huge recession, markets were pricing only 128 bps of cuts for the consecutive 12 months.
Why would bond markets be so aggressive now?
In a nutshell, there are two main reasons:Labor Market and PCE Inflation
The first reason has to do with the Fed’s mandate – one could argue the job is done.
The labor market is back in balance (glass half full) and judging from the trend in private job creation at only 115k/month and steadily declining one could argue there are risks it’s weakening too much (glass half empty).
The labor market isn’t remotely hot anymore: job done?
Core PCE (the preferred Fed’s inflation measure) is already annualizing at 1.9% which is below Fed targets.
Further disinflationary tailwinds from the delayed pass-through of weaker rent inflation and a softer job market should corroborate the trend in H1 2024.
The underlying trend of core inflation is already consistent with 2%: job done?
The second argument for so many cuts priced in is tightly connected to the first.
If the Fed’s job is done, what’s the appropriate level of Fed Funds?
Back to neutral over the next 12-18 months.
And if anything, markets are more sanguine on where neutral Fed Funds are than the Fed is.Fed Funds Estimates
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