U.S. equity markets reached new highs last week as the Federal Reserve (Fed) solidified its gradualist strategy for monetary policy normalization at its annual event in Jackson Hole. Fed Chair Powell continues to see strong U.S. economic growth supporting the gradual increase in interest rates. With these comments, the odds are very high for a September rate increase, and are greater than 50% for a December one.
The equity markets viewed the Fed’s comments as dovish due to the view that preemptive interest increases were unnecessary and coincidental economic indicators are appropriate for setting policy. As the yield curve continues to flatten, however, the fixed income markets had a different interpretation. Fixed income investors seem less convinced the economy will remain strong with the current expected pace of policy tightening, thus causing the yield curve to invert and slowing economic growth. This dynamic will likely keep the markets’ attention for the remainder of the year.
I don’t think the Fed wants the yield curve to invert, and I believe the odds of a December rate increase are much lower than the market currently expects.
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