Simplifying the Rates Market

As we approach next week's Jackson Hole Economic Symposium and more central bank speakers, I think it is a good time to really simplify how to think about the rates market. Tapering Is a Non-Event For all the handwringing, for all the taper-tantrum headlines, I believe any sort of tapering the Fed is likely to deliver is already priced in. Sure, if the Fed announced a dramatic plan to taper immediately markets would be spooked, but that isn't what we will get. We will get some tapering that starts in the future and is very gradual. I don't see that moving markets and if anything, I think we could see a collective sigh of relief as we can move on from this topic. No Inflation, No Hikes I think we can all agree that if we don't get persistent and high inflation, the Fed will not hike rates. They probably won't taper either, but I don't believe tapering is a big deal either way. That leaves us with just one question: If we get inflation, what will the Fed do? In my view we will see persistent (a year or more) of higher inflation (averaging round 2.5%) over that extended time period. But for now, let's not argue about inflation and just assume that it is running hot. What Will the Fed Do? They will stick to their script of saying it is transitory. After transitory can no longer be used, they will talk about multi-year averages being the key metric. Once that doesn't work, they might act, or might come up with a new excuse, but hiking is not in the cards for at least a year, if not much longer. Basically, the Fed will do nothing is my assertion, which I will explain in more detail next. Why Will the Fed Not Hike? Why take the risk of taking the foot off the gas too early? Personally, I think Ben Bernanke kept too many policies in place for too long and that started us on this easy money addiction -- but what I think is largely irrelevant because we did keep it on for so long and he is largely lauded for his efforts. So, many central bankers view that part of the problem with the global economy is that they keep taking away easy money too early. They will not make that same mistake this time around. Economic models haven't worked well Things like the Taylor Rule Phillips Curve have not worked, giving central bankers an excuse to avoid doing what the models suggest and being more aggressive for longer. Labor force participation From 2000 until 2008 the labor participation rate was around 66%. That dropped after the financial crisis, though it seemed to stabilize around 63% from 2013 to 2019. We are under 62% right now. We have fewer people wanting to work while job openings remain high (the JOLTS data showed 10 million job openings at the end of June!). That is 3 million more jobs than in 2019 and well above a 20-year average of 4.6 million jobs. Not only are jobs available, but pay seems to be increasing across the board. This low level of labor participation represents slack and is why the Fed will be slow to act. Digging deeper into the data We all fixate on the headline numbers and let's be honest, there are so many headline numbers that just trying to keep up with them is overwhelming. But the reality is that the Fed is digging ever deeper into the data. As you did deeper into the data, additional stories and themes emerge. While the unemployment rate has dropped back to 5.4% the US Unemployment Rate for Blacks/African Americans is still at 8.2%. While monetary policy is a very blunt tool for dealing with social and economic inequality, it is certainly something that the current policy team (Treasury and the Fed) is trying to address. More than ever before, subsets of data, often ignored, are being looked at and influencing policy. Not only is that likely a good thing, but identifying what is important to the Fed now is crucial to understanding what they plan to do. Bottom Line Expect tapering, but expect it to be largely priced in. Do not expect rate hikes, regardless of your view on inflation. This combination should keep rates somewhat rangebound, though I think, over time, if the economy isn't slowed by COVID or a weak fiscal stimulus package, rates will drift gradually higher. That helps to explain the strength we are seeing in fixed-income products and a recent influx of money.

Simplifying the Rates Market

As Jackson Hole approaches, here are my views on tapering, rate hikes and the markets.

Columnist Conversation

This Could Get Messy

Latest AAP Podcast With Helene Meisler!

This Weekend on Real Money

COLUMNIST TWEETS

Please Join or Log In to manage and receive alerts.