13 July 2023
The battle between the Fed and the bond market continues, with each side delivering blows to the other. The Fed’s rate-hiking regime, though not a serious challenger, can influence the behavior of the bond market to some extent. However, the bond market has shown resistance and disagreement with the Fed’s inflation concerns. The fight intensified last year, with inversions spreading and deepening. While the Fed attempted to raise rates, bond yields remained stubbornly low. The market struck back with a banking crisis, causing rates to plummet. The conflict revolves around the definition and impact of interest rates. The Fed’s belief in raising rates to fight inflation is met with skepticism from bond market participants who view falling rates as a sign of deflation and economic weakness. The events in September and October, which included a collateral run, marked the initial stages of the banking crisis. The bond market’s counterpunch against rate hikes highlighted the deflationary consequences that would follow. Despite acknowledging an upcoming recession, the Fed remains committed to further rate hikes, prolonging the anticipated pivot. Inversions persist, indicating resistance and the potential for another blow from the bond market, possibly related to collateral tied to commercial real estate and commercial mortgage-backed securities (CMBS). While the outcome of this battle remains uncertain, it is clear that the fight has been about more than just inflation. We all stand to lose regardless of the outcome, with modest contractions and transitory inflation pressures being the likely result. The fight was never about neutrality.