Deutsche Bank’s latest monthly report highlights a significant dislocation in global markets: bond market pricing suggests the Federal Reserve will cut US interest rates by 1 per cent within the next six to twelve months. This is far from President Trump’s desired 3 per cent cut and would bring the total easing to 2 per cent, a level typically seen only during recessions. However, risk assets, such as global equities, remain at all-time highs, and credit spreads are historically tight, contradicting expectations of an economic downturn.
Adding to the confusion, inflation swaps indicate that inflation is expected to rise, further diverging from the rate cut expectations. Deutsche Bank macro strategist Henry Allen suggests that markets may be overestimating the Federal Reserve’s dovishness, a pattern observed over the past two years. Hedge fund billionaire Ray Dalio echoes this sentiment, arguing that current market conditions signal that interest rates are already too low, reflecting easy money and a healthy economy.
The differing views between market signals and President Trump’s calls for lower rates may stem from a deeper conflict over the value of money, according to Dalio. In an environment of massive debt, pushing real interest rates down and devaluing money benefits debtors but harms creditors. Economist Mohamed El-Erian suggests that the pressure on Federal Reserve Chairman Jay Powell to lower rates is unlikely to subside and even proposed that Powell’s resignation might be the best way to protect the Fed’s independence.
Despite the resilience of the US economy, Goldman Sachs warns it could hit “stall speed” as job creation slows, maintaining a 30 per cent probability of a US recession. Investors are now faced with the question of whether Wall Street can continue to disregard the political and economic pressures in Washington and Main Street, betting on the exceptionalism of the American corporate sector.
