Is the Bond Market Forcing the Fed’s Hand to Hike Faster?


by Mish Shedlock, Mish Talk:

In a word, no. Let’s discuss what’s really going on.

Half-Point Rate Hikes in May and June? 

Yesterday, I noted Half-Point Rate Hikes in May and June? That’s What’s Priced In!

A couple of my readers misinterpreted that as if the bond market was forcing the Fed.


That’s not really what’s happening. Rather, the Fed does what it wants 100% of the time and will make excuses to get what it wants.

If anything is forcing the Fed it’s inflation, but inflation marched higher for over a year with the market barely moving at all.

Fed’s Primary Tool is Communication

The Fed’s primary tool is communication. If the bond market and Fed Funds Futures don’t do what the Fed wants, the Fed communicates endlessly.

That’s why despite surging inflation, yields barely moved for a long time.

Big Swift Kick in the Pants

Recall that 50% was a 90% chance for March until a parade of Fed presidents walked it back.

There is no functioning market here. The Fed views communication as its primary tool. The market front runs Fed communication.

Recall my February 11 post The Fed Uncertainty Principle and a Big Swift Kick in the Pants

Does the Fed follow the market’s lead? Most believe so, but it’s not quite that simple.

Bullard gave the market a kick. The market responded by pricing in a 50 basis point hike for March.

For whatever reason, Powell didn’t like it. Then a literal parade of Fed presidents walked back the hike to 25 basis points.

Does the Fed Follows the Market?

Most think the Fed follows market expectations.

However, this creates what would appear at first glance to be a major paradox: If the Fed is simply following market expectations, can the Fed be to blame for the consequences? More pointedly, why isn’t the market to blame if the Fed is simply following market expectations?

This is a very interesting theoretical question. While it’s true the Fed typically only does what is expected, those expectations become distorted over time by observations of Fed actions.

The Observer Affects The Observed

The Fed, in conjunction with all the players watching the Fed, distorts the economic picture. I liken this to Heisenberg’s Uncertainty Principle where observation of a subatomic particle changes the ability to measure it accurately.

The Fed, by its very existence, alters the economic horizon. Compounding the problem are all the eyes on the Fed attempting to game the system.

A good example of this is the 1% Fed Funds Rate in 2003-2004. It is highly doubtful the market on its own accord would have reduced interest rates to 1% or held them there for long if it did.

What happened in 2002-2004 was an observer/participant feedback loop that continued even after the recession had ended. The Fed held rates rates too low too long. This spawned the biggest housing bubble in history. The Greenspan Fed compounded the problem by endorsing derivatives and ARMs at the worst possible moment.

The Fed has so distorted the economic picture by its very existence that it is flawed logic to suggest the Fed is simply following the market therefore the market is to blame. There would not be a Fed in a free market, and by implication there would be no observer/participant feedback loop.

Fed Uncertainty Principle

The Fed, by its very existence, has completely distorted the market via self-reinforcing observer/participant feedback loops. Thus, it is fatally flawed logic to suggest the Fed is simply following the market, therefore the market is to blame for the Fed’s actions. There would not be a Fed in a free market, and by implication, there would not be observer/participant feedback loops either.

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