The big bet on lower rates is over

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Welcome to what Goldman Sachs calls “reflation despair.” For policymakers and investors, it will be a nauseating and likely long journey.

This embarrassing reset happened because it turned out that the inflation dragon hadn’t been slain after all, although markets actually declared victory late last year.

A hard-hitting reading of consumer price index inflation in the United States can be considered a misfortune. Two, it looks like negligence. Three months out of three, as is the case now, is impossible to explain. The fact that the increases are small and that it is not the measure of inflation favored by the Federal Reserve is not enough to cancel out the signal, especially when we combine this week’s exceptional data on retail sales in the United States.

The big bet of a rate cut – and it was huge – is dead. At the start of 2024, we expected six or even seven US rate cuts this year. It already seemed silly at the time, but it plays out in a humiliating way. Today, markets are looking at one, maybe two.

Bank of America pushed back its call for the Fed’s first cut from June to December — a huge jump for an adjustment that typically takes place in increments of one or two months at a time and which opens up the very real possibility that cuts may not take place at all this year. Goldman Sachs, once part of the “five cuts” camp, has now gone from three to two, starting in July rather than June. Bond prices have fallen, dragging stocks down with them.

How did everyone get carried away with the idea that rates were poised for an aggressive cut? It certainly seems time for all parties to do some soul-searching.

The main reason is that we are stuck in old ways of thinking, convinced that inflation will fall back to something that seems to be the norm and central banks will rush to retreat into the warm waters of low interest rates which dominated the post-crisis period. until the arrival of war and plague. The reality is clearly more complicated than that.

For a while, there was a clear dividing line: Markets repeatedly reacted to signs of potential declines, and central bankers doused them again, reminding investors of their sacred duty to contain inflation. It was as if markets were from Mars and policymakers were from Venus, looking at the same facts and drawing radically different conclusions.

For Jean Boivin, a former deputy governor of the Bank of Canada and now global head of research at the BlackRock Investment Institute, additional complications arose during the Fed’s rate-setting meeting in December. Then the central bank kept its rates unchanged, but also did not react to growing market expectations that they would start falling quickly, and even announced that it would cut them three times in 2024.

“Central bankers are behaving more like traders lately,” Boivin said. “They were aware of the uncertainty, but they said they were going to take a gamble. They bet everything on impeccable disinflation. . . This story of Mars and Venus has been reversed. Or maybe they’re both on Venus.

To be fair to bond investors, few sincerely believed in seven cuts, but probably three or four, plus some hedges against a really bad recession. And in fairness to central bankers, steering monetary policy through a storm of shocks, including frozen supply chains and war on European soil, is no simple task.

The introspection began. The Bank of England, for example, just completed a study led by former Fed Chairman Ben Bernanke, which concluded that British policymakers had demonstrated “significant shortcomings” resulting from faulty thinking, software outdated and difficult to communicate clearly. The Fed has now also acknowledged that it takes “longer than expected” to bring inflation under control.

It is a rich elixir for political zealots who wish to blame rising inflation and falling living standards on independent monetary policymakers, and for investors eager to find someone to blame for their market mistakes.

The reality is that this is what data addiction really looks like – the mantra of policymakers. Rate makers are less able to give investors clear guidance on what will happen next because they are as easily swayed by economic data as the rest of us. They may never achieve their mission of being boring again in our lifetime. As long as deglobalization, the green transition and increased budgetary spending in areas like defense persist, inflation will fluctuate and cause sudden changes of heart. We all must learn to live with changing narratives and markets.

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