Would the rate hikes next year shove the economy into a big, fat slowdown?

Outlook: News releases today include the Philadelphia Fed and Kansas City Fed manufacturing but the usual Thursday weekly jobless claims is going to hog the headlines. Bloomberg foresees 260,000 in new claims, a post-pandemic low. After the Bureau of Labor Statistics admitted the biggest error of all time—an undercount of jobs by 626,000 in the June-Sept period—the Fed is going to have a hard time claiming it’s waiting for the employment situation to normalize before acting.

On that front, JP Morgan Chase joined the herd of big banks now expecting the first rate hike—in September. On the same day, the yield on the 10-year fell from 1.63% to 1.60%. Wait a minute—rising rate hike expectations should have the opposite effect, shouldn’t it? We are getting a Treasury auction of 10-years today that could turn out to be interesting.

The bond market is confounding everyone and not just us. The Daily Shot published one of the most peculiar charts of all time—see below. We couldn’t access the accompanying story but have to wonder if this is not the same tune we were playing yesterday—that the short end needs to go up and a lot, while the long end could turn down if the market comes to perceive that the rate hikes next year will shove the economy into a big, fat slowdown (if perhaps not an outright recession). In other words, inversion or near-inversion.

It doesn’t seem reasonable that the short end responds to inflation now but the long end is responding to deflation 6-9 months in advance of an event that may never come. We await expert advice on whether the decision horizon can differ so much. Meanwhile, the FT has just discovered that the divergence in monetary policy attitudes at the ECB vs. other big central banks is behind the euro’s drop. In the UK, the yields are flat on the week, down on the monthly basis (-0.25%) but up 0.73% year-over-year. How’s that for confusion? See the comparison with the US. When it comes to the currency, though, the pound is staging a pushback against an oversold condition that is roughly parallel to the euro. We expect sterling to go up, but on positioning, not necessarily an embrace of imminent rate hikes on headline inflation up 4.2%, as reported this week.

We expect the dollar to return to its rise as soon as the correction is ended. How long will it take? Nobody ever knows and sometimes it runs away from us and becomes a reversal, but the odds of that are pretty small this time. The US has seriously strong growth (however transitory), unemployment meeting or nearly meeting the Fed’s criteria, a stable financial sector and an accepted announcement of tapering without a tantrum. Whether the first rate hike is in June when tapering ends or not until September hardly matters to the dollar, and only a unhappy Shock like a Covid Wave Four can derail things now. Let’s note that usually the US follows the UK but that seems reversed this time, in part because the UK has an extra factor, Brexit, that is so confusing only about seven people actually know what’s going on and the rest of us have Brexit fatigue and can no longer bother to follow it.

So wait for the pushback/correction to end before loading up on dollars again. In sterling, that could be around 1.3670. In the euro, far more—1.1620. That’s based on the ichimoku cloud but other indicators of resistance would put the turning point far lower. A hand-drawn resistance line in the euro lands at 1.1540, for example. We never know in advance which indicator the market will choose.

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