Wednesday's Market Minute: The Burden Of Proof Is Shifting Back Onto Deflationists

It’s not showing up in Fed funds futures pricing yet, but the market is starting to put pressure on the Federal Reserve to hike again. The good news is, it’s also sending a message that our economy can handle it.

The latest big move is in crude oil, which finally turned a two-month bounce into a full-fledged breakout. WTI is up seven of the past eight sessions and nearing $90 again. Extended supply constraints from the Saudis was the headline Tuesday, but the trend has been building despite weakness in China and serious economic faltering in Europe. Perhaps those two risks have been fully priced in, or perhaps American travelers just can’t be stopped; either way, there is a very real demand component behind oil’s move.

The U.S. dollar’s also rallying again. Unimpressive foreign economies are supporting the greenback, but inflation’s still a problem basically everywhere but China. The dollar’s rise to the highest since the March regional bank crisis is telling us more about what the Fed can’t do (cut) then will do (maybe not hike). Sharp traders should remember that in 2021 and 2022, the dollar was the most predictive asset of hawkish surprises from the Fed.

All of this adds up to higher Treasury yields. Bond bulls tried to push rates down after some softer labor data early last week, but it doesn’t look like it took. With the jobs market resilient, bargaining power favoring workers, and commodity prices proving uncooperative, the burden of proof is quickly shifting back toward those who believe the disinflation of the past year is a one-way trend, and that the Fed’s work is done.

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Stocks probably won’t like this, but don’t panic! There’s also some good news. For the first time this late in a cycle ever, the Treasury yield curve is uninverting, i.e., steepening, due to longer rates rising faster than shorter-dated ones. That’s never happened in any recession since 1970. As I wrote last week, the curve usually steepens by way of lower short-term yields due to Fed cutting. If yields continue to rise in this style, it means the economy is stable despite what the Fed's doing, and they should feel fine continuing to fight inflation.

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