The final few months of 2023 saw a remarkable rally in the US bond market, with yields falling to levels not seen since last July. According to Fathom analysis, long-term rates had been driven higher until that point largely by monetary factors, such as the level of the policy rate and the volatility of both the policy rate and inflation, rather than by fears about the US fiscal position, or views about the equilibrium real rate of interest. Our central scenario for the US economy is one of ‘immaculate disinflation’, where inflation continues to fall as inflation expectations adjust, rather

The bond market remains confused about interest rates, which is why it continues to generate such unusual levels of volatility. One possible explanation for this ongoing uncertainty is that there is a fundamental difference of opinion between bond traders who have only experienced abnormal bond market conditions since 2008, and those who are, let’s say, long in the tooth. During the first half of 2023, the US 10 year nominal bond yield averaged just 3.63%, with the 30 year benchmark at 3.78%. The market appeared to be indicating that inflation would quickly fall back to 2% and that nominal demand

Will the US avoid recession? Multiple indicators are pointing towards a soft landing. Twelve-month core inflation is on a clear downward trend, falling 2.5 percentage points from its peak in September 2022; and high household consumption has led to strong real GDP growth, of 2.9% over the last four quarters. Refresh this chart in your browser | Edit the chart in Datastream With core inflation falling, the Fed kept the federal funds rate unchanged in the range between 5.25%-5.50% in its meeting on 1 November, meaning that the rate has remained at a constant level since July. Refresh this chart in your

The FOMC increased its benchmark interest rate by 25 basis points after its July meeting, as had been widely anticipated. There was no surprise, either, in the accompanying statement, which differed little from June’s. However, there was a change of tone in the press conference that followed. In response to a question, Jay Powell said that the Fed staff are no longer forecasting a recession. Market participants have increasingly priced in this type of ‘soft landing’ scenario. Despite still-high inflation, risk assets have done very well this year alongside expectations for relatively steep interest rate cuts next year. Such an

Easing US recession fears and increasing expectations of a Fed ‘pause’ have contributed to a new, positive mood in US markets, aided by technological optimism about the possible benefits from AI. The S&P 500 was more than 20% off its cyclical lows during trading earlier this week, although whether this is a bear market rally or a new bull market, it is too early to tell. The outlook for inflation and all its associated implications for Federal Reserve policy will continue to prove critical, as they have done for several quarters now. The US labour market report for May surprised

Markets on the whole do a decent job of synthesizing information at the micro level, but they often get the macro signals wrong as was noted by Paul Samuelson. In his 1998 paper, Samuelson argued that there is no persuasive evidence that macro market inefficiency is trending towards extinction. One factor behind this inefficiency is that markets can progress at times based on memory rather than a random walk. This has particularly been the case for interest rates since the Greenspan Put was put on steroids in 1998 when Long Term Capital Management defaulted. The so-called Greenspan Put is where

The second-fastest Fed hiking cycle of recent times created its first casualty in the US banking sector last week, also reawakening fears about European banks, as the dramatic changes in the fortunes of Credit Suisse show. It appears that some US banks have been guilty of too lax an approach towards portfolio diversification, resulting in a situation where the prices of all held assets were strongly positively correlated — creating a highly concentrated risk around the path for rates. With yields rising as the Fed remains hawkish, many bank investments have been falling in value. Had these losses been booked

The late economist Axel Leijonhufvud noted in a 1979 essay that the theory of the interest rate mechanism remains at the center of the confusion in modern macroeconomics. All the inconclusive quarrels, he argued, largely stem from this source. While financial market academics continue to argue the merits of their preferred theory – whether it be IS/LM based models, Keynes’ liquidity preference or the loanable funds theory – bond traders have had to deal with the reality of conflicting interest rate signals. The recent dramatic shift in the path of interest rates indicates fixed income markets have become, in the

Federal Reserve officials have hinted that the speed of interest rate rises may “soon” begin to ease, according to the minutes released last Wednesday from its November meeting. Markets responded positively, with the S&P 500 ending the day up 0.6%. The news came after another 75 basis points hike on top of 3.25, continuing the second steepest hiking cycle in the Fed’s history — a speed which reflects the size of the task facing the Fed.  The officials cited “uncertain lags and magnitudes associated with the effects of monetary policy actions on economic activity” as the reasons for potentially beginning

Those who ascribe to ‘sell in May and go away’ would have avoided one of the two times this year where the S&P 500 declined more than five percent in single week (the other instance occurred in late January). Many thought that U.S. inflation expectations peaked in March this year as April numbers saw a decline across both headline and core CPI.  However, headline CPI reached another new high in May rising 8.6% year-over-year, a 40-year high as shown in Exhibit 1.  Core CPI also remained stubborn on a month-over-month basis as it rose 0.6% showing no decline from April.

In an earlier article, ‘Behind-the-curve Fed signals more rate hikes’, Fathom Consulting reflected on the careful balancing act that the US Federal Reserve must perform as it embarks on a series of rate hikes. Tighten too quickly and it risks tipping the economy into recession; tighten too slowly and upward price pressures could become entrenched, requiring an even quicker pace of tightening down the line that could prove more costly. For emerging markets, where central banks typically have less credibility, the balancing act is much more precarious, forcing them to start the tightening cycle much sooner, and harder, in order

With the US economy back above its pre-crisis level of output and with inflation overshooting the Federal Reserve’s target, investors are shifting their focus towards the outlook for monetary policy. Speaking on 3 March, Jerome Powell, the chair of the Fed, confirmed plans to raise rates in March as inflation remains persistently high. Fathom expects the FOMC to announce a 25-basis point hike, although the risk to this is to the upside with markets last month pricing in a more than 90% likelihood of a 50-basis point hike. More hikes are expected this year. The prospect of US monetary tightening