The wind up for the most telegraphed rate hike in history was supposed to achieve one thing: generate benign inflation in the form of a rising short end and a broadly steeper yield curve, or in short: boost inflation expectations without crashing the market (recall after 7 years of ZIRP and QE all the media is blasting is that “rate hikes are good for stocks”) – after all why else would the Fed be hiking rates if not to offset the market’s inflationary expectations and to have “dry policy powder” ahead of the next recession, even if said powder was a meager 25 basis points.
It was most certainly not supposed to achieve this:
This is how Nomura summarizes the chart above:
“with deflation fears in the air and oil getting floored, inflation products have already become an unloved asset class. If the Fed surprises the market with a September hike, we expect all BEIs to fall under pressure but likely led by the <5yr sector as risk markets also crater. Just like currently, BEIs are held hostage to commodities and credit markets even as the Fed probabilities are being revised down.”
Here is a better way of summarizing it: the last three times inflation expectations tumbled this low, the Fed was about to launch QE1, QE2, Operation Twist and QE3.
And the Fed is now expected to hike rates in less than a month even as inflation expectations are the lowest since Lehman?
Good luck. The Fed – which is damned if it hikes rates (and crushes financial conditions by tightening, sending deflationary signals surging even higher and undoing 7 years of stock market levitation), and damned if it launches QE4 (as it loses all verbal jawboning credibility it worked so hard to establish in the past year ) – is now truly boxed in.
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