Over the past couple of years the market has persistently misjudged expected inflation and its impact on interest rates. In a recent presentation to its investors, Hudson Bay Capital noted that while in July, 2021 the market believed there was only a 6% chance that the 10-year US Treasury rate would go above 2.5% in one-year's time, despite clear signs of increasing inflation. In July, 2022, market expectations were still slow to adapt, increasing to a 13% chance of the 10-year US Treasury yield going above 4.0% in one-year's time.
Yet we are no strangers to high interest rates, with historical 10-year yields since 1970 averaging above 6.0%.
The market's pattern of slowly changing to the new norm reminds me of the oil price slide in 2014, caused by the supply growth from shale-oil production and stagnating global oil demand. The market and industry persistently believed that oil would quickly return to $80-$100/barrel despite clear evidence from supply and demand economics that oil prices were going to stay sub-$60/barrel for a while.
In recent comments after the surprising jobs report came out last Friday showing the US added 500,000+ jobs (https://www.wsj.com/articles/feds-jerome-powell-to-address-economic-outlook-with-hiring-surge-in-spotlight-11675781503?mod=economy_more_pos1), Chairman Powell continues to reiterate rates will continue to be high as it may take "quite a bit of time" for rates to slow down inflation.
The question today is not when this year will the Fed start lowering interest rate - instead, the question should be when will the market wake up to the new reality of higher interest rates compared with the low rates we've been spoiled with over the last decade.
"To improve is to change, so to be perfect is to change often." - Winston Churchill