The bond market is talking, and the Fed should listen.
Bond markets have staged quite an impressive sell-off over the last two weeks.
Apparently, this happened without a catalyst.
But if you look under the hood, the drivers for such a move seem clear:
1) US real growth data keep showing resilience
2) Core inflation seems to be stabilizing close to 3% (not where the Fed wants it)
3) Yet, Powell will most likely cut rates again tonight
With such a constellation of variables unfolding, the bond market is sending some clear signals - and the Fed should listen.
The chart below shows the US 10-year Term Premium as derived from the ACM model.
Notice how we had a spike back up to +30 bps, just a whiff away from the cycle-highs in term premium seen during the bond meltdown of late 2023.
The Term Premium is the compensation that investors require to hold long duration bonds and hence interest rate risk.
The higher the expected growth and inflation volatility down the road, the higher the expected bond volatility and the higher the required Term Premium to compensate investors.
Bond investors are basically telling the Fed this:
''You are cutting while nominal growth remains robust, and you could end up re-igniting inflation; we want more compensation to hold long bonds and we are watching you closely''.
Do you think Powell and the Fed should listen?
And therefore be more hawkish?