The Market is Pricing in Too Many Rate Hikes. Here’s What the Fed Will Do Instead.

The market has priced in more than four interest rate increases this year from the U.S. Federal Reserve to tone down inflation and remove monetary stimulus.

There are some people who believe that won’t be possible.

That stock market investors in particular will rebel, as they did in late 2018, to the point that the Fed will have to stop its rate hiking cycle, and instead find other means to cool demand and slowly let more air out of the asset bubbles the central bank helped create.

One of those skeptics is David Rosenberg, Chief Economist and Strategist at subscription service Rosenberg Research.

Here are a few hi-lights from a report, courtesy of the The Globe & Mail, which features the full report, in which Rosenberg spells out what he believes the Fed will do, and the one key thing to watch out for that could signal a recession.

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by David Rosenberg, Chief Economist & Strategist, Rosenberg Research

Primer on the Fed

• Now that the Fed has got the market reset for four rate hikes this year, I think the bigger surprise will be a quicker taper and move to quantitative tightening (QT) because it is the most efficient way to cool demand without crushing it.

 

• What’s been happening of late is that the Treasury market has done its repricing of the Fed and the stock market is following with a lag.

 

• And mostly importantly: don’t ever mess with the yield curve — an inversion of the 2s/10s curve has foreshadowed all six recessions in the past 40 years (it has never flashed a “head fake”).

 

There are too many rate hikes priced in, but the big deal is the end of QE and the onset of QT (farewell to the “wealth effect” on spending).

 

So at this point, based on what’s priced in, I think the surprise will be that the Fed does less (not more) on rates, and that means the Eurodollar futures are attractive, the conditions for a steepener in the Treasury market curve led by the front end look like a solid bet.

 

I would expect that we will also see mortgage spreads, and in fact all spread products, begin to widen out — especially so in the high yield market where investors seem to be living in a la la world of zero defaults.

 

So part of this trade includes trading up in quality.