Key Insights
- FED rate cut decision risks a stagflation environment. Here’s what this could mean for the markets.
- Why the FED is stuck between a rock and a hard place ahead of the upcoming FOMC meeting.
- Short-term pleasure, long-term pain scenario could be at play as the yield curve adopts an uptrend or un-inversion.
The market predicts an 87% chance that the FED may cut rates by 350-375 basis points. However, the FED’s dual mandate also underscores a major challenge.
The Federal Reserve (FED) will hold its next FOMC meeting next week, and the stakes remain high. This is because the FED has been playing a balancing act between inflation and unemployment.
The FED’s rate cut decision depends heavily on the state of the U.S. unemployment rate. Elevated unemployment has been a major challenge in recent times.
Many analysts anticipate a FED rate cut to stimulate the market and possibly help boost the job market. However, doing so also risks causing higher inflation.
Analysts Express Concern Over Potential Stagflation Risks
The remedies that the FED applied in the last few months barely triggered any improvement. And while some believe that the FED will be forced to cut rates once more, the tariff wars have already created an unstable economic environment.
Moreover, analysts now believe that the situation could lead to stagflation. In such a scenario, inflation and unemployment would both remain elevated while economic growth would contract, leading to more economic pain.
This kind of scenario is what the FED has been trying to avoid. While this scenario highlights some of the risks ahead, shifting gears towards the yield curve reveals something even more concerning.
Perhaps a runaway train that not even the FED intervention can stop. The yield curve has been steepening for the last 1 year or so, after previously experiencing an inversion.
This yield curve highlights the relationship between short-term and long-term bonds. A yield curve inversion has historically signaled that the market was in a recession.
However, a steepening highlights the end of an inversion, with the yield curve switching back above zero.
The Bravos Research chart highlighted zones in the last where steepening occurred after yield curve inversion.
According to the research, the markets experienced a recession within one year after each steepening recovered above the 0 line.
Likely Scenarios as Attention Shifts Towards the FED’s Next Move
The yield curve’s steepening highlights one of the biggest challenges behind the FED’s current conundrum. Increasing rates at the current yield curve level risks economic cooling.
On the other hand, lowering rates risks higher inflation. The spread between unemployment and interest rates may offer insights into how the FED will likely navigate the situation.
The FED funds rate highlights the reaction to the unemployment and interest rate gap. Historically, the FED tends to raise rates when the RHS adopts an uptrend and cuts when it adopts a downtrend.
This brings us to the latest market conditions. Unemployment data recently came in lower than expected, which may offer some relief.
However, inflation remained elevated, but this extremely sensitive scenario may explain why investors have been sitting on the sidelines.
The stakes are simply too high, hence highlighting uncertainty. However, that could change depending on the FED’s upcoming decision.
Nevertheless, these observations may still underscore significant risks in the coming months. This could continue influencing investor sentiments and possibly suppressing liquidity flows.