Some views may have changed ..... but not everybody's


ref:- "MUFG Scraps Yield Curve Inversion Call" and "Goldman, JP Morgan Still Betting on 5 Rate HIkes by End 2019"

Both in Bloomberg Markets

There was an old trader of our acquaintance who would always greet a difference of opinion with a shout of "That's what makes a market !". It was a mildly amusing routine for a spell, but fairly swiftly became a bit tiresome .... and is even more so now that we realise that inadvertently in our weaker moments, and as result of constant exposure in our early years, we can on occasion wheel out the same line ourselves.

Disappointing .... but in fairness to the old boy, he wasn't wrong. Essentially, opposing views are exactly what makes a market, and on scanning through Bloomberg it's interesting to see what amounts to two directly contradictory forecasts side by side.

Those market heavyweights Goldman Sachs and JP Morgan Chase have reasserted their shared opinion that there will be five more rate hikes by the US Federal Reserve by the end of next year -- which is to say one next month, and four more in 2019.

It no longer looks like quite such a nailed-on certainty, but it is still highly likely that the Fed will raise rates by 25 basis points in December. So leaving that one aside, it's the call of four hikes in 2019 that catches the eye. Such a scenario has always been a touch on the hawkish side. The Fed itself has only ever forecasted three rises for next year, and the market (as defined by the price of Fed Funds and Eurodollar futures contracts) has usually pointed to something a little more dovish.

The market did briefly get up there when things were at their most exuberant, but it currently suggests that even two hikes are looking a bit doubtful. In that, it fairly accurately reflects where general sentiment is headed at the moment even if Goldman and JP Morgan don't agree.

MUFG's views might reflect the more pessimistic outlook that is holding sway just now. Some outside of the market may not recognise them in quite the same way as they would those two marquee names maintaining the hawkish bent, but MUFG predicted the flattening of the yield curve (the contraction of the difference between short-end rates and long-term rates) very nicely, thank you. Much of the rationale behind the curve flattening call was the aggressive tightening of short-term rates by the Fed , and in fact MUFG believed that the curve would actually invert -- in other words, short rates higher than long ones. Given that inversion of the yield curve has often preceded recession, that would be no small thing.

Now they've abandoned the inversion call, in the belief that the changing economic outlook will force a Fed re-think. Falling global equity prices, a trade war with escalating effects on the economic growth, the diminishing effects of the fiscal stimulus derived from tax cuts, a slowing Chinese economy -- there's no shortage of factors why the Fed might choose to change their intended policy. And in truth, though the Fed are so far sticking with the three hike call, there have been more doveish noises emanating from key personnel, including Chairman Jay Powell. It's almost as though they are entertaining at least the possibility that the pace of rate hikes so far may already be being felt.

Here's a horrific thought ..... just imagine that President Trump, railing against the Fed and castigating them from raising rates too fast, is proved right -- we would never hear the end of it. That's some way away yet, but MUFG have re-adjusted their base case scenario to just ONE 25 bp hike in 2019, and one more in 2020. That represents a huge divergence of opinion between themselves and Goldman / JP Morgan. Right at this faltering moment, four hikes does feel a bit toppy, and even if the Fed should begin to change their line immediately you'd have to imagine that their credibility might take a bit of a pasting. On the other hand, this could all be a bit of a blip ..... we've seen enough of them before. Surely they wouldn't have misjudged the effects of their actions so far by such a margin ?

Not normally, no ..... but a lot of factors are at play in the global economy and many of them are outside of the control of the Fed and very hard to predict.

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