Central Bank Interest Rates

The US yield curve is sending a crucial signal here. The chart shows how all post gold standard recessions (shaded in orange) have been anticipated by the following pattern: yield curve inversion (2s10s in blue), time lag, steepening, recession. This is exactly the pattern we have followed since June 2022 – but why does it work this way? Yield curve inversions signal monetary policy is too tight: companies and households face harsher credit conditions and hence cut their borrowing activities – with a (variable) time lag the economy slows down. At this point the yield curve steepens. That’s either because the economy or markets broke: the Fed must cut rates fast = bull steepening (2008). Or because it’s taking too long and a ‘’this time is different’’ narrative forces higher term premium and even harsher credit conditions late cycle until eventually breaking something = bear steepening (1980s, today). The inversion has now lasted for 16 months and as the dangerous late-cycle steepening is unfolding under our very eyes it could be beneficial to have a check with Dr. Yield Curve. The passage of time is a boring but crucial variable in this relationship: the longer the yield curve remains inverted the longer markets are signaling tight credit conditions for the private sector. That matters because a longer yield curve inversions means the tightening is getting transferred to a larger and larger proportion of corporates and households. The most recent example concerns the 2008-2009 GFC: the Fed hiked rates rapidly and went for a loooong pause in 2006 by keeping rates ‘’higher for longer’’ for several quarters. The yield curve inversion which started in early 2006 lasted for a long time hence spreading the tightening deeper into the US economy until it finally cracked the housing market and a severe recession unfolded. We are now at month number 16 of persistent yield curve inversion which is being followed by a playbook steepening. And it's the post-inversion steepening you should worry the most about. Interested in trying my institutional research? Send me an IB chat on BBG!

Dueling Mandates The Federal Reserve’s dual mandate - to foster price stability and full employment - is rapidly morphing into a dueling mandate. The Fed’s Beige Book revealed that the labor market remains stuck in its low hire, low fire, stagnate mode, while inflation is accelerating. It noted stickiness in service sector inflation and incidents of opportunistic pricing. The latter are price hikes on goods that are not directly tariffed but benefit from the lack of completion that tariffs trigger. Shifts in the data prior to the shutdown further complicated the Fed’s assessment of the economy. Employment was revised down, while economic growth was revised up. That is unusual - understatement. Preliminary reports on the third quarter reveal an acceleration of consumer spending. What we have to ask ourselves is why? Is it due to inequality, doing more with less or a measurement problem? Probably some combination of all of the above. The measurement issue is the most important to the Fed. The official data often is slow to capture rapid shifts in the economy. Staffing shortages are worsening that problem. More than a third of the prices in the August CPI were imputed, as field officers were idled earlier this year. How does that distort our view of the economy? If we are undercounting inflation, then we are overstating economic growth. Chair Powell used the words “may be” when talking about the recent strengths of the economy. Revisions could reveal a weaker economy - that is what doves on the Fed are betting. If they are not, we could have more support for inflation than is understood. Adding to the uncertainty we face is the government shutdown, which leaves us with a dearth of data and could be more consequential to the economy than past shutdowns. It is hitting more workers that past shutdowns with threats of larger cuts & ripple effects to the communities in which they live. The bulk of those workers live outside of the beltway in DC. Another challenge for the Fed is inflation expectations. Research by the Boston Fed suggest that expectations may be becoming unmoored, or normalized. Tariffs typically represent a one-time bump in prices, which is self-correcting. The sequencing of tariffs on the heals of the pandemic inflation has left them mimicking inflation. That could further normalize inflation and make it a self-fulling prophecy. Bottom Line The Fed is left with “no risk-free path” for policy. If it doesn’t cut, it risks a recession. If it cuts too aggressively, it could stoke a more persistent bout of stagflation. That has left it moving with caution instead of certitude, cutting in 1/4 point moves to avert the worst in labor market weakness without stoking inflation. Prospects for 2026 are murkier & could shift with changes in Fed leadership. History is unkind to central banks which prioritize employment over inflation. Any gains in employment tend to be short-lived & stoke a more entrenched bout of inflation.

The Federal Reserve is facing a problem that goes deeper than interest rates or inflation prints. I've written my thoughts about it this morning in this article. These are my thoughts. The Fed's own mandate is pulling it in two directions at once and the strain is starting to show. There is a split inside the committee, which became very evident yesterday. Policymakers who share the same data are reaching very different conclusions about where rates should go next. The problem is that the Fed is expected to deliver both stable prices and something it calls maximum employment. The first has a clear target. The second does not. It is a judgement that shifts with demographics, technology and global supply patterns. When inflation remains above target but labour market indicators soften, the mandate offers no obvious hierarchy. Some officials believe employment risks must take priority. Others insist inflation should dominate. This tension matters because it shapes how markets interpret every signal the Fed gives. A divided committee rarely tells a clear story and clarity is the currency central banks trade in. As the world economy changes at speed, does the dual mandate still help the Fed or is it becoming an obstacle to the very stability it is meant to support? The other the question to ask is whether this dual mandate actually threatens the Fed's independence i.e. whatever decision it makes is questioned politically, making it vulnerable to political attack. What are your thoughts?

Why Has the Fed Cut Interest Rates by 0.5% While the Bank of England Held Steady? The recent decision by the Federal Reserve to cut interest rates by 0.5% while the Bank of England has chosen to keep rates unchanged highlights a key difference in how these central banks approach their economic responsibilities. Although both are tasked with maintaining financial stability, their mandates and priorities diverge, leading to different strategies in response to similar economic conditions. The BoE’s primary mandate is to manage inflation, thereby ensuring price stability by keeping inflation around its 2% target. In recent times, the UK has experienced inflationary pressures, partly driven by supply chain disruptions, rising energy prices, and other global factors. By the BoE holding rates steady, they signall that controlling inflation is more important than short-term economic growth. This conservative stance reflects the view that failing to address high inflation could lead to greater economic instability in the long run. In the BoE’s framework, the priority is clear: inflation management comes first, and the focus is on preventing inflation from spiralling out of control. Growth is a secondary consideration. Therefore, even if growth slows down or there are concerns about a potential economic downturn, the BoE’s stance remains firmly centred on inflation control, as persistent inflation can erode purchasing power and destabilise the broader economy. A cut in interest rates would risk fuelling inflation further, which the BoE sees as too high a cost to bear at present. On the other hand, the Fed operates under a dual mandate. This means the Fed must balance two equally important objectives: keeping inflation stable while also promoting maximum employment and economic growth. With this dual mandate, the Fed has a more flexible approach, as it is required to support economic activity while keeping an eye on inflation. In the current environment, the Fed has seen signs that US economic growth is weakening—whether due to slowing demand, challenges in the labour market, or external global pressures. Although inflation remains a concern, the Fed judged that an interest rate cut was necessary to prevent a significant economic slowdown. By cutting rates, the Fed aims to encourage borrowing, investment, and spending, which can help stimulate economic growth and support employment levels. This decision reflects the Fed’s broader remit to foster conditions that promote both stable prices and robust economic activity. The 0.5% rate cut, therefore, is not just a reaction to inflation but also a pre-emptive measure to avoid a potential recession or economic stagnation. Therefore, the difference in response is likely due to diverging mandates. The BoE, focused almost entirely on controlling inflation, therefore keeps rates steady to prevent further inflation. But, the Fed is balancing inflation concerns and economic growth/employment, so cuts rates.

The #FOMC minutes provide the clearest articulation yet of the #Fed's reaction function under Chair #Warsh, marking a shift from broad risk-management language toward explicit scenario-based policymaking. In scenarios where #inflation resumes its decline toward 2%, "most" participants discussed maintaining or eventually lowering the policy rate. Conversely, if inflation remains elevated because of strong #AI-related demand, tariffs, or the conflict in the Middle East, "almost all" judged that some additional policy firming would likely be warranted. While this does not constitute forward guidance, it makes the Committee's reaction function considerably more transparent.

Federal Reserve hiked rates by 25bps to 5.25-5.50%. The FOMC statement is almost a mirror image of the previous one, with the only significant change being a move to 'moderate' growth from 'modest'. I speculated that the Fed might modify the phrase "inflation continues to be high" to reflect some improvements, but it remains unaltered. This subtly indicates that the strategy is to persist with rate increases at alternating meetings, and the market currently forecasts a 16% probability of a rise in September and a 40% likelihood in November. Here's a succinct summary of the statements made by Fed Chair Powell, categorized by topic: Employment and Labour Market: • The pace of job creation remains robust. • Signals of labour supply and demand are nearing equilibrium. • Demand for labour significantly outstrips supply. • Some weakening in labour market conditions is anticipated. • The noted weakening is not through a rise in unemployment, but rather a decrease in job vacancies and resignations. Inflation: • Inflation has slightly eased but still significantly exceeds the 2% long-term target. • The journey to bringing inflation back to 2% has a considerable distance to cover. • Overall inflation has significantly reduced due to falling energy and food prices. • Core inflation, still high, is anticipated to decrease. • The general scenario reflects credit conditions that are becoming increasingly stringent. Economic Growth: • Economic growth at moderate or modest levels is desirable. • A surge in growth could fuel inflation, potentially necessitating policy interventions. Monetary Policy: • Decisions are evaluated on a meeting-by-meeting basis. • Monetary policy, seen as restrictive, is believed to be curbing economic growth and inflation. Future Outlook: • The plan is to maintain restrictive policy levels to tackle inflation. • Should data imply the need for more rate hikes, the committee stands ready to act. Overall, the market appears relatively stable, though I perceive a bias towards strengthening of the dollar, contingent heavily on economic data. The basis for this will start with the US reports scheduled for release tomorrow, which include: • Preliminary Q2 GDP • Durable goods orders • Initial jobless claims • Advance goods trade balance #fomc #federalreserve #powell #usd #markets #monetarypolicy

#WallStreet Anticipates #Aggressive Rate #Cut Wall Street has significantly raised its expectations for the #FederalReserve to implement an aggressive 0.5 percentage point interest rate cut during its upcoming meeting this week. The shift in sentiment is driven by recent US economic data showing signs of a slowdown in the labor market and cooling inflation. #Key #Factors Influencing #Expectations: 𝙇𝙖𝙗𝙤𝙧 𝙈𝙖𝙧𝙠𝙚𝙩 𝙎𝙤𝙛𝙩𝙚𝙣𝙞𝙣𝙜: Recent job reports indicate fewer jobs added in August and July, raising concerns about potential economic weakness. 𝙄𝙣𝙛𝙡𝙖𝙩𝙞𝙤𝙣 𝘾𝙤𝙤𝙡𝙞𝙣𝙜: Headline inflation has dropped to 2.5%, moving closer to the Fed’s target, though core inflation remains elevated due to pressures in the housing market. 𝙈𝙖𝙧𝙠𝙚𝙩 𝙎𝙚𝙣𝙩𝙞𝙢𝙚𝙣𝙩: Stock markets have responded positively to the rising expectations of a rate cut, with the S&P 500 nearing record highs and the Dow Jones Industrial Average hitting new records. #Market #Perspectives: -ANDY brenner of Natalliance Securities believes a 0.5% cut is warranted, pointing to weak retail sales data expected this week, which could further support the case for a larger cut. -J.P. Morgan economists also support the idea of a half-point cut. -However, Subadra Rajappa of Societe Generale suggests that a 0.25% cut is more likely, citing the Fed's history of aligning its actions with market pricing. This would mark the first rate cut since 2020, signaling the Fed's response to growing economic uncertainties. However, a larger cut could also suggest heightened concerns about the overall health of the US economy, which some experts are cautious about. Based on an article by Kate Duguid in Financial Times Graph created in Bloomberg

The Fed Cut Rates, But Can It Cut Unemployment? The global economy is at a crossroads again. After months of caution and mixed market signals, the U.S. Federal Reserve finally pulled the lever cutting interest rates by 0.25%. This marks not just a monetary shift, but a strategic one: from fighting inflation to stabilizing employment and restoring growth momentum. Yet beneath the headlines, a deeper story unfolds. While cheaper borrowing costs promise relief for businesses and households, the question remains Will this new liquidity translate into real job creation, or merely accelerate automation and cost-cutting? In this edition, we unpack the implications of the Fed’s decision: how it affects corporate cash flow, global capital markets, the ongoing U.S. government shutdown, and the widening gap between AI-driven prosperity and human-centered employment. Because in today’s economy, lower rates alone don’t guarantee higher opportunity it’s about where the money flows, and who it reaches.

The Federal Reserve has delivered its second consecutive rate cut, lowering the target range for the federal funds rate to 3.75% to 4%. Chairman Powell emphasized that another move in December is not a foregone conclusion despite investors' desire for further easing. The Fed is still navigating a complex and uncertain economic landscape. The impact of this is to reduce restriction of the economy. The easing trend is being reflected in falling borrowing rates as well as yields paid to savers. The Fed’s official statement noted that “downside risks to employment have risen,” even as inflation remains somewhat elevated. That highlights the tricky balance between supporting the labor market and maintaining progress on inflation. Complicating matters, the federal government shutdown has created a logjam in the release of key economic data. That doesn’t mean there’s no information available. Private-sector surveys, market indicators, and state-level data continue to offer important signals; however, they make policymaking more challenging when the official numbers arrive late or in piecemeal fashion. The latest decision also revealed strong differences of opinion among FOMC participants, with one member favoring a larger half-point cut and another preferring no change at all. Those dissents underscore the uncertainty surrounding the policy path, particularly with mixed signals from inflation and employment. By announcing an end to balance sheet reduction beginning in December, the Fed is signaling it wants to stop tightening financial conditions further. Still, officials remain committed to a data-dependent approach, assessing new information as it becomes available. In short, the central bank is trying to strike a careful balance, supporting a slowing economy without reigniting inflation pressures. Any incoming data, particularly if the federal logjam breaks, could help determine whether this recalibration continues or pauses.

What do rock legends AC/DC know about the US bond market? …they know the yield curve is “Back in Black” ⚡️🎸⚡️ As the chart shows, the US yield curve has been inverted since March 2022. Yesterday’s dis-inversion - and the yield curve moving back into the black - shouldn’t really surprise us. After all, short term bond yields have fallen quickly over the summer, as expectations for Fed cuts have grown. Traders now assume some 100bp of Fed cuts before the end of the year, and policy rates at 3.5% before the middle of 2025. What’s more, Powell’s recent speech - which shifted the Fed’s focus away from inflation and toward unemployment - has validated expectations for an imminent Fed and global rate cut cycle But the concerning thing here is that a dis-inverting yield curve, driven by bull steepening, is a robust leading indicator of recession. Even if the yield curve is just a “mirror”, reflecting the bond market’s best guess about future interest rates, it looks like an important cyclical change is underway as growth and labour market data cool quickly. That should put investors on alert, although a soft-ish landing remains our base case I still expect the yield curve to “structurally steepen”. But the most important thing to watch now is how far - and how fast- the curve steeepens. A gradual steepening toward a normal, say +50bp slope, would be fully consistent with a soft landing, and a broadening out pattern in stock markets. A more aggressive steepening would be a worrying reflection of a harder economic landing materialising … and that might leave investors “Thunderstruck” , or even on a “Highway to Hell” ⚡️🎸⚡️ #acdc #economy #investing