Insights

The Fed may soon be forced to choose which market it wants to protect, and neither path is completely painless.

USD money markets currently view monetary policy as modestly accommodative. According to the 42 Macro Market-Implied Fed Neutral Rate Model, the Fed may need to hike two to four times to return policy to neutral after the U.S. neutral rate rose roughly 100 basis points since February.

If the Fed falls short of market expectations over the next 12 months, it will signal a preference for supporting stocks at the expense of bonds. With inflation remaining sticky, that decision could agitate bond vigilantes and push sovereign yields higher.

The details of the Q3 Quarterly Refunding Announcement continue to support our core research thesis that a Geopolitically Driven Supply-Demand Imbalance in the Treasury bond market will force the Fed and Treasury to rely on increasingly dovish monetary and net financing policy over the long term. In our view, the persistence of this imbalance reinforces why the Fed has little choice but to continue monetizing U.S. sovereign debt over time.

At the same time, the June JOLTS report revealed an awkward dichotomy in the U.S. labor market. Depressed labor-market turnover points toward slower wage growth, while demographic-driven reductions in labor supply point toward faster wage growth. How this dichotomy resolves itself will be key to collapsing uncertainty surrounding the Warsh Fed’s reaction function.