We’ve written a lot about how there are, to our mind, essentially two strategies for rates.

Firstly, we look back at the 2018 cycle, when the Fed raised rates to ~2.5%, and, the economy slowed sharply, inflation fell, and the Fed was forced back down to ~1%.

Along came the pandemic, and the fed funds rate went to zero.

So, the point is; it’s very difficult to see why we would have a fed funds rate closer to 5%, for the next few years.

That suggests they’ll be cutting, and, if they’ve overcooked things, potentially a recession.

Back to our view on rates.

You can stay predominantly short duration, largely floating rate exposures, and get good yields. You’ll miss out of course if the “overcooked” part is correct, as duration will likely produce capital gains.

However, time is probably on your side. The Fed is still hiking, and you can usually start to rotate duration when the Fed actually begins to cut, and still collect a lot of yield + duration on offer in say intermediate treasuries.

Or, you can hand-wave away the precise timing, decide that 10s at 3.5% is good enough, and (ideally!) enjoy the benefit of negative correlation in the short run (assuming it is there).

In our view, either is fine.

Maybe the main point of the note is to remind ourselves that in 2018 the Fed tried to lift off from the zero lower bound, caused a mini-manufacturing recession, and had to reverse track, as did the ECB.

If the pervasive forces that were in play then (a lower r*, the natural rate of interest consistent with stable inflation and an economy producing at potential output) are still with us now, then there is no way the fed funds stays near 4-moving-towards-5%.

That’s why the market is pricing a 150bps worth of cuts across the back end of the curve.

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