A Decent -- Yet Ultimately Messy -- Setup

I for the most part concur with MRB Research’s Prajakta Bhide’s assessment of the macro setup for 2026.

Highlights:

• A smaller trade policy drag than last year, a fiscal policy boost and supportive financial conditions will lift growth above potential this year

• Resilient consumption, and growth in investment, both A.I. and non-A.I., will boost growth.

• Labor demand shows nascent signs of stabilizing. The unemployment rate is unlikely to rise much, if at all, this year.

• Looking past recent data distortions, the underlying trend of inflation is still firm and well above the Fed’s target.

• Firmer growth implies cyclical upward pressure on inflation.

• Optimal policy calls for no rate cuts this year, even if the Fed is under intense pressure to ease. Unwarranted rate cuts will put upward pressure on long-term bond yields.

Bullet points 1 through 5 should ring familiar with clients and blog-readers/watchers... I.e., our stated expectations of somewhat less-raucous geopolitical rhetoric and policy out of the US going forward, fiscal stimulus, a firming of overall general conditions (per the latest reads from our PWA Index), and durably stubborn (above consensus/above target) inflation going forward.

The thing about #6 is that presently the market is pricing in 2 Fed rate cuts by year-end… Clearly, MRB expects the Fed will change its tune as the data roll in… All the while you can rest assured that the incoming Fed chair will be doing everything in his (assuming it's Warsh, and assuming he gets appointed) newly-appointed capacity to (despite his reputation) convince the board that rate cuts are indeed appropriate, and the sooner the better.

So, if indeed the voting governors relent, and MRB (and yours truly) have the setup correct, rates on the long-end will rise to meet rising policy-aided inflation risk, which will ultimately make things messy for risk asset markets (after, that is, the initial pop higher on rate cut(s)) – make no mistake.

Now, the plus (and no doubt Warsh's [and, yes, Bessent's] intention) for cutting rates, despite the data, is its effect on the space in the curve (the short-end) where the treasury will be borrowing to fund its not-small deficit going forward... I implied above that rate cuts into a strengthening economy actually raises borrowing costs, which is true, but only as you move out the curve (longer-term debt)... The short-end, particularly 0 to 2-year maturities, will come down immediately with any and all Fed rate cuts... And that's right where the treasury is looking to borrow going forward.

Stay tuned…

P.S. I'll be away for the office the rest of this week... So, nothing further herein till the weekend... Have a great week!