With Powell effectively confirming an earlier end to the Fed’s taper program this week, parts of the US yield curve inverted, and as the chart below shows, forwards traders are starting to price in rate cuts in a few years suggesting the Fed will not only end its tightening campaign prematurely, but will be forced to cut relatively soon.
And, we would add, the more stocks drop, the greater the priced in future rate cut will be. In fact, with the forward swaps curve now pricing in more than 10bps of cuts, we are now where we were in late 2018, just weeks before stocks tumbled 20% and Powell capitulated, sparking a massive rally as the Fed's last brief tightening cycle came to an abrupt close.
In inverting, the US curve joined the UK, Europe and especially many Emerging Markets where yield curves have already inverted aggressively.
Commenting on this inversion, DB's chief FX strategist George Saravelos argues that the omicron variant – irrespective of the precise immunological properties – would just help reinforce existing trends, not change them. It is a fallacy that the market has been “looking through” COVID.
What does he mean by this? In his own words: "weak US labor supply, strong inflationary pressure in the goods sector, high excess saving, very low terminal rate pricing, a stronger dollar and very negative real rates are all because of persistent COVID forces this year not despite of them. It’s the new “COVID normal”, very different from the “old”. Is the market right to price such late-cycle dynamics?"
His conclusion: "If the whole point of the Fed turning hawkish is to slow the economy down and take the unemployment rate back above the “new” NAIRU, the answer is yes."
The only problem: Powell is also taking down the entire market down with him, and today risk assets made it clear that they will not go down without a fight, and will push back until Powell capitulates on his rate hiking plans.