Financial markets are increasingly trading on what Deutsche Bank describes as “a ‘peak inflation’ world view.' The idea being broadly embraced for now is an impending U.S. economic slowdown and/or recession is likely to cure the problem of high inflation.
Financial markets are increasingly trading on what Deutsche Bank describes as “a ‘peak inflation’ world view” — one that would entail a less aggressive response from the Federal Reserve than previously feared, even though inflation has yet to show signs of demonstratively peaking.
That thesis is reflected in inflation breakeven rates trending between 2.18% and 2.6% as of Friday, plus a notable drop in yields on 5-, 10- and 30-year Treasury inflation-protected securities over the last few days, according to Tradeweb data. In addition, most Treasury yields fell below 3%, while fed funds futures are trading at levels which imply Fed officials could back off of a 75-basis-point rate hike in favor of a smaller 50-basis-point move in September.
Last July, Heppenstall was one of the few people to openly say that the bond market might be underestimating the chance of a prolonged spell of higher inflation, a spell which came to fruition. Now, he said, the Fed is unlikely to push its main policy rate target above 4%, from a current level between 1.5% to 1.75%, without “driving the economy down to a point where the Fed overdoes it.”
A raft of weak data is cementing the idea that the U.S. is heading into a slowdown, sending all three major stock indexes DJIA, -0.43% SPX, -0.93% COMP, -1.87% lower in the afternoon and investors flocking to the safety of government bonds. Data released on Friday showed signs of a worrying deterioration in the economy, as reflected in preliminary data from S&P Global’s purchasing managers’ indexes.
Of the five scenarios he envisions could unfold, the one that the market is mostly “flirting” with right now involves a “soft landing,” or no recession, and a terminal rate of 3% to 3.25%. Meanwhile, the market and the Fed are prone to “push back” against a second scenario in which inflation remains mildly stubborn, the U.S. experiences a shallow recession, and the terminal rate goes to between 4% and 4.25%.
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