Lower interest rates is the uncrowded trade

I don’t know why people make it so difficult for themselves.

The bond market is ‘more correct’ than the rhetoric or ‘tough talk’ that central bankers provide.

The former isn’t emotional while the latter is and susceptible to biases.

The U.S. 2 year bond yield started rising and forecasting higher interest rates in October 2021, when it passed the 0.30% level.

By the time the Federal Reserve announced its first rate hike on March 17th, 2022, the U.S. 2 year bond yield was 2.20%

I think it is a waste of time speculating or debating if the Fed will ‘pivot’ and change direction.

Firstly, a reversal of current direction is not an automatic occurrence. The Fed can keep rates where they are for a little more.

Secondly and more importantly, the bond market will tell you more.

Currently, 2 year bonds are yielding 4.15%.

Much is priced in and now poised at stretched levels.

The chart below shows the Fed raising rates by a factor of 12 from the 0.25% low.

This is in belated sync with the 11 to 13 fold hikes seen in many other economies while those commodity sensitive nations (where the citizens are least indebted compared to those in the G10) such as Brazil, Chile and Mexico all started hiking rates (trying to fight inflation) between March 2021 and June 2021.

The most crowded trade, thesis and belief is still – for higher rates.

Not many are calling lower rates.

I am.

For various reasons, I think this U.S. 2 year bond yield falls back to the 2.30%-2.60% range in the coming 10-20 months.

Does this mean that the Fed cuts rates into the next year?

Perhaps, Yes. Maybe taking the Fed Funds Rate to 2.75%

But I can’t see how they can raise rates another 1% with out ‘breaking something’.

October 6, 2022

by Rob Zdravevski

rob@karriasset.com.au