Consensus would have the Fed start cutting rates by or before August as shown by the Fed funds futures (see chart). Short of major events or crises, the market may be mispricing Fed’s expectations for at least three reasons.

First off inflation is yet to be vanquished and nowhere close to the 2% target. In fact, looking at forecast core PCE, a metric that is particularly relevant to the central bank, the March reading is slightly higher than February’s. The same is also confirmed by stubbornly low unemployment and wage growth data. The latter is still above 6%. The Fed also understands that any number of external factors may reignite inflationary pressures and must do as much as possible as fast as possible to get it to the lowest possible trend/level.

The second reason is the US political cycle. As the 2024 elections are getting closer, the Fed’s optionality to maintain restrictive conditions is about to close. As we get closer to the elections political demands that the central bank relinquish rates and increase liquidity will only grow louder. The window to suppress inflation in earnest is in other words closing.

The third and perhaps most compelling reason is “credibility”. The failure to correctly identify inflationary pressure in 2021 and stubbornly maintaining the issue was “temporary” has tarnished the Fed’s reputation. More importantly the same failure also required the most extreme tightening in recent history and, indirectly, caused the liquidity crisis in the banking sector. In the world of “credit”, a word coming from the Latin “credere” or “to believe”, reputation is everything. Their price stability credentials need to be reestablished at all cost. Should that require further decline of asset prices, so be it. Not the least also because the latter will be supportive of reducing inflationary pressures.

After almost two decades of never ending monetary easing, recency bias among participants is to be expected. More cognisant investors should rather understand that the world has moved into a new regime. The four “Ds” of debt, demography, deglobalisation and decarbonization, inflation is likely to ebb and flow and so are interest rates levels. There is no going back to “free money”. The implications for asset prices are very significant. Bonds real returns will be meager and equity prices will largely move sideways on an aggregate basis while experiencing extreme return dispersion across sectors. More importantly, volatility and risk will continue to be elevated as we navigate the transition to a vastly different global order from the one we have become accustomed to.

Disclosure: Not investment advice. Do your own research. Hold all assets mentioned. Twitter @pietroventani for more timely comments and updates