Are We Walking on Thin Ice? A Quick Pulse Check on the Booming Supportive Backdrop
For a while now, I’ve been shouting about how stocks should stay buoyant thanks to the sweet, spring‑in‑the‑tail policy backdrop. Investors feel comfy piling into riskier assets, believing that inflation’s return to the 2% target makes the central‑bank “put” both back in play and a lot more flexible.
In plain terms: G‑10 central banks can hit the rate‑cut button whenever they want, by any magnitude, and pour in as much liquidity as they please. They’ve essentially won the war against double‑digit inflation, so now everyone whispers, “time to loosen.”
But Watch Out—The Biggest Catch is a Premature End to the Relief Cycle
Even while the narrative is all “cut and keep cutting,” there’s a looming phantom: the probability that the Fed will snatch its knife from the table and pull back to neutral rates sooner than the consensus expects. Markets already price that away, but fresh signals suggest the odds are creeping up.
1. Fed Voter Mester Taps the “Raise Forecast” Switch
Yes, our dear Mester, who’s leaving mid‑year, has hinted she might lift her long‑run fed funds rate projection. If other FOMC members echo that, we’ll see a higher “neutral” anchor point. That means a shrunken, shallower easing run to reach the new target. The less the cuts, the kinder it could be for the markets.
2. Real Fed Funds Rate at an All‑Time Low—What Does That Say?
Chair Powell’s preferred gauge uses the one‑year inflation breakeven estimate. By that measure, the real fed funds rate is at its lowest in a year—a sign of ultra‑loose policy. When policy loosens and the real rate slides, the appetite for a nominal cut dwindles. It’s a kind of “do we really need to add more fuel?” kind of scenario, especially with some market corners (crypto, for instance) already steaming on speculative fire.
These developments are worth flagging, but they haven’t yet forced me to ditch my baseline view: the policy quo is still likely to push risk assets higher.
Still, A Heatwave in Jobs or Inflation could Flip the Script
If the jobs tally hits a fever‑pitch or inflation rises sharper than expected, the Fed might surprise us by delaying the liquidity injection. This pause could even trigger a 25‑basis‑point hawkish tweak in the 2024 median dot at the March FOMC meeting. The fallout? We could see the dollar surge again while Treasuries take a dip.
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