The problem with this thesis is it discounts the tough decisions that face the central bank, given the chance that inflation stays elevated for longer than anyone wants.
"If the market really thinks the Fed [is] going to start cutting rates next year, I'd like what it's smoking," Hewson said.
Already, there are signs that sentiment is starting to weaken again. US stock futures are down after the S&P 500 snapped its four-week winning streak on Friday. They could continue to drop as yields on 10-year US Treasuries, which move opposite prices, push back up toward 3%, making riskier investments look less attractive. The US dollar is also moving higher, indicating a waning appetite for risk.
Breaking it down: The Fed faces a difficult set of choices. Minutes from its latest meeting, which were released last week, highlight the stakes.
The central bank said that "uncertainty about the medium-term course of inflation remained high" and noted that price rises are well above its 2% target, which indicates it will need to stay tough. At the same time, it said it "would become appropriate at some point to slow the pace of policy rate increases," since there is a lag time between action and when the effects are reflected across the economy.
Investors have honed in on the latter language. But how chill can the Fed really get as long as its preferred measure of inflation is more than double where it wants it to be?
"We need to get inflation down urgently," Minneapolis Federal Reserve Bank President Neel Kashkari said at an event last Thursday, pointing to interest rate hikes as the best way to reduce demand and lower prices.
There are three Fed meetings on the calendar between now and the end of the year. And if the central bank really wants to get its target rate to between 3.75% and 4% by then, as some members have indicated, it would need to hike rates by three-quarters of a percentage point once more in September, or opt for a trio of half-point rises. Neither option sounds particularly dovish.
If markets continue to rally, it also could make the Fed more likely to hew hawkish, since it wants financing costs for business to rise, not fall, as stopping inflation remains the top priority.
Goldman Sachs told clients on Monday that "downside risks loom," noting that the path for inflation and growth, which determine what the Fed does next, will also dictate where the market heads.
On the radar: Attention now turns to Jackson Hole, Wyoming, where Chair Jerome Powell is scheduled to speak at the central bank's annual symposium later this week. Nicholas Colas of DataTrek Research notes that the S&P 500 is down just 5% since the last Jackson Hole event. Does that really reflect all that's changed during that time?
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