The dotted lines show the market-derived forecasts while the solid lines shows some valuable historical context.

We know rates in the US are going to be cut in September and will continue to be lowered from there. The pace is uncertain but what really matters for the market is the destination.

Apollo argues that the floor for rates is now higher, likely even higher than the 3% priced in. That’s a commonly-held belief and it’s based on the idea that we’re in some kind of new higher-inflation era due to deglobalization or other structural factors.

I disagree. I think the same structural factors that led to rates falling to 0% to 1% in the past three cycles still exist. Yes, there might be some more friction in global trade but it’s hardly a gamechanger, especially in a world that’s increasingly technologically driven. Moreover, the AI and robotics revolution is likely to lead to a dramatic improvement in productivity, which is deflationary. At the same time, it will lead to many layoffs (or less hiring) and that will cap any wages gains.

Again, there are arguments for higher inflation like climate change and debt monetization that are somewhat compelling but on net, I think disinflation wins out. And while I think the Fed will be shy about lower rates below 2.50% in a downturn, as the job losses mount, they will undoubtedly cut further.

Ofcourse the timing of that is highly uncertain and Powell could execute a perfect landing in this cycle that keeps rates near 3% but at some point a recession will come and rates will go back to 1%.

In the short term, I think that’s an important consideration for duration trades because there is still the opportunity to lock in a safe(ish) 4-6%. The idea of higher rates in the US and USD exceptionalism is also a big part of the backing for the crowded dollar trade. As that illusion vanishes, expect pressure on the dollar.

One potential hiccup in that is the Fed Chair. Powell and most of the Fed core is aligned on this thinking but if we get a more-hawkish Fed chair appointed next (Waller?), then it could change the equation, though we would also have to consider the downside growth prospects that would come with unnecessarily high rates.