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Is The Market Betting On A Fed Pivot Again?

October opened with a glimmer of hope, in contrast to the doom and gloom in September. All asset classes rallied strongly yesterday. This definitely provided much-needed relief for those holding on to their long positions.

Assets 1-Day Performance on 3 Oct 2022
Assets 1-Day Performance on 3 Oct 2022

Bond yields above 1-year dropped across the board and the dollar retreated albeit slightly.

Treasury Yield Curve Movement (3 Oct 2022)
Treasury Yield Curve Movement (3 Oct 2022)

And as of now, the current odds of Fed Funds rate at year-end is leaning towards 57% for 4.5%, and 42% for 4.25%, with an insignificant number pricing in 4%.

Target Probabilities Fed Funds Rate For Dec FOMC (Source: CME Group)
Target Probabilities Fed Funds Rate For Dec FOMC (Source: CME Group)

Aside from technical reasons, it seems that the market is also looking for the Federal Reserve to moderate its aggressive stance given recent developments. The global market has witnessed cracks surfacing with pressure coming from the Fed's relentless push for higher rates in conjunction with quantitative tightening that send the dollar rapidly higher.

Already under the effects of high inflation, a strong dollar is making it worse for other countries. And the conflict between politicians and the central banks in handling this tough period is put to the utmost test. Emerging markets are coming under the heat with some abandoning the conventional policy of increasing interest rates to fight inflation and opting to ease rates instead. Turkey is one, and its inflation rate just hit 83%.

Even developed nations are not spared. The Bank of England (BoE) has to do an emergency move to buy up long-dated bonds to stem the rout in UK Gilts and the pound after the UK government announced historic tax cuts earlier. Eventually, the UK government made a U-turn and decided to abolish the tax cuts.

External agencies such as United Nations Conference on Trade and Development (UNCTAD) have also called on the Fed to cool its hike. And within the US, housing and manufacturing are slowing at a faster pace than expected. So market participants are probably looking at the Fed to buckle next.

But will Fed give in? I think the markets have been conditioned to think they will as they have done so for over a decade. However, the Fed's credibility has already been seriously questioned after being late in reacting to soaring inflation. What we have seen so far is a Fed going around playing catchup, stamping on brakes, and flooring pedals. To give them room to wiggle out of their current stance, I think the labor market needs to soften and inflation comes down faster. The US non-farm payroll is coming out this Friday 7 Oct 2022. If hiring and wage growth slows and unemployment climbs, in particular, if they miss the forecast on the downside, you can expect the markets to pop champagne over that. Strange as it may sound to some of you who are new, this is the market today - a market that is still seriously in love with the Fed and hoping that its lover will come back to them with open arms.

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