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IPFS News Link • Federal Reserve

Powell May Not Know It Yet, But The Fed Is Now Trapped

• https://www.zerohedge.com

With even Morgan Stanley openly discussing whether the Fed will "make the market happy", it now appears that the Fed tightening is effectively over with the Fed Funds rate barely above 2%, and the only question is whether the Fed will cut rates in 2019 or 2020 - roughly around the time the next recession is expected to strike - and whether the balance sheet shrinkage will stop at the same time (and be followed by more QE).

To be sure this new consensus was reflected in both equity and credit markets, both of which cheered the Fed's recent dovish U-Turn, and recouped all their losses since mid-December. And yet, market paradoxes quickly emerged: for one, rates markets yawned. On December 31, rates were pricing no Fed hikes over the next two years. Today, after the Fed's big 'change of tone', expectations are almost exactly the same.

Second, a material disconnect has emerged between front-end pricing (no hikes) and the level of 10-year real rates (near seven-year highs). If, as Morgan Stanley's Andrew Sheets notes, "one of these is right, the other seems hard to justify."

Then there is, of course, the lament about the neutral rate being so low - and the potential output of the US economy so weak - that it can't sustain nominal rates above 2.25% - incidentally we explained back in 2015 the very simple reason why r-star, or the real neutral rate, is stuck at such a low level and is only set to drift even lower: record amounts of debt are depressing economic output, as the following sensitivity analysis showed.


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