The last few months have seen U.S. bond markets reprice interest rate cuts, down from seven rate cuts this year to only one, and possibly even a rate hike.

Wait what, a hike?

Maybe, and while Federal Reserve (Fed) Chair Jerome Powell dearly wants to cut rates, recent CPI, PCE, PMI and employment data continue to suggest that chatter about meaningful cuts and pivots are still way ahead of reality - as I’ve been suggesting for a very long time.

Over the past few weeks, we’ve seen a downdraft in risk markets.

This has been a direct response to various Fed governors signalling that Chair Powell’s declaration of victory against stubborn non-transitory inflation, was premature.

Their view? Simple. Interest rates will remain in restrictive territory until the job is done, for as long as it takes.

And that might be awhile.

Why do I say that? Because instead of issuing new long-term Treasuries to fund the Government, Treasury Secretary Janet Yellen, could pay her bills by:

• Directly spending funds from the treasury general account (TGA) exactly like she did in May 2022 and like in May 2022 she again has ~US$0.94 trillion to play with.

• Borrowing short term (no coupon payable) from the reverse repo account (RRP) that sits at ~US$0.5 trillion.

Direct fiscal spending of up to US$1.45 trillion would be highly inflationary.

In the meantime, bond prices are weakening on the expectation of continuing inflation and firming yields (with many calls for 10 year yields to rise well about 5%) and stocks outside the Mag 4 and pockets in energy have been battered, while money market funds offer a solid alternative to risk assets (nice!).

Bottom line?

• The Powell Fed has repeated the mistakes of the Burns Fed of the 1970s by waiting too long and restricting too slowly. Inflation has become ‘baked in’ or pernicious. This is despite historical evidence of how inflation comes in waves, and the lengths the Volcker Fed had to go to in the 1980s to vanquish pernicious inflation caused by the 1970s Burns Fed.

• Treasury has access to ~US$1.45 trillion of inflationary dry powder in the TGA and RRP, which, if it were to be spent, the Fed’s attempts to arrest inflation might just be thwarted. Oops.

Add to that GDP weakened in Q1. Double oops.

If that leads to rising unemployment (big if, thus far) and if the Fed and Treasury moves create more currency debasement and/or inflation, then we would have all of the ingredients necessary to enter a period of stagflation.

So far? Not there yet.

I answer what this might mean for the West Australian economy in our subscriber only macro digest newsletter, NextPerspective.

If you engage in corporate development for your company or your clients and would like to know the answer, the Autumn edition will be out on Wednesday at 10am and you can apply for access by tapping on the subscribe button.

See you in the market!

Mike