By Kevin Muir
Remember back a few years ago when all the hard-money advocates were complaining about how the Federal Reserve was distorting the economy with their zero interest rate policy? Hedge fund managers like Greenlight Capital’s David Einhorn constantly harped about the artificial “sugar high” the aggressive monetary policy stimulus was inflicting on both markets and the economy. These disciples kept pushing for higher rates. Immediately. Like yesterday.
Well, they got their wish. After six years of leaving rates basically at zero, in 2016 the Federal Reserve embarked on a tightening campaign and rates have been marching higher ever since.
I can already hear the complaints from the hard-money crowd about why this isn’t good enough – the Federal Reserve is raising rates, but it’s been at a glacial pace. And no doubt they are correct. This has been one of the slowest tightening cycles on record. And let’s face it – two hundred basis points of tightening in two and a half years is not that much.
Yet, the reason for the dawdling pace of rate raises can best be summed up by one of Forest for the Trees’ Luke Gromen’s tweets:
Never has the world been this indebted. To think this massive debt burden won’t affect the economy’s sensitivity to rate hikes is just naive.
I have no desire to engage in a discussion about the correct course of Fed action. I have my opinion, but it means squat. I am much more interested in figuring out what the market believes.
During the past two years, the whole LIBOR curve has been pushing higher. For example, here is the Eurodollar 3-month future yield curve today and one year ago:
Easy to understand. The whole curve has shifted higher as the Federal Reserve has raised rates.
But the developments of the past month are much more interesting.
Rates at the front end of the curve have risen, but instead of the whole shifting higher, the long-end has fallen in yield. Stop and think about that development.
Although we are miles away from being inverted as the front part of the curve is still relatively steep, the market is sending signals that the end of the tightening cycle might be in sight.
Eventually, at one the FOMC meetings, the Federal Reserve will raise rates and everything but the short-end of the yield curve will rally. At that point, the Federal Reserve will have hiked rates into the next recession.
And make no mistake. The market will know before any Federal Reserve official. There is no better signal than the yield curve.
Don’t ignore the shot across the bow that this recent flattening of the LIBOR curve is flashing. The current economic cycle is already one of the longer ones on record, and even though the Federal Reserve has been slow in raising rates, it might take fewer rate hikes than in previous cycles. Don’t bother arguing with the hard-money gurus about the correct policy course. Just watch the yield curve. The market is smarter than all of us.
Thanks for reading,