The consensus view on interest rates is that the new Fed Chairman Kevin Warsh is going to hike at the next FOMC meeting on 29 July. The rhetoric is that inflation has been on the rise and is ‘higher for longer’ and, at his first press conference, he struck a hawkish tone which took many by surprise as he was expected to be Trump’s dove. Pursuant to this, the market has two hikes priced in, but we think that’s not how things will play out.

So why do we say inflation’s peaked? Our macro process is based upon the rates of change of growth and inflation. Regarding inflation the most important input to the model is the oil price and that has fallen some 40% from its recent peak. This will drag down CPI significantly when it is next reported on 14 July. We use Hedgeye Risk Management’s algorithm to track these rates of change, and their models have been incredibly accurate in measuring and mapping inflation up from the lows and now as they peak. What other signs can we look to?

Bond yields are usually a good tell and both the 30 year and the 10 year yields peaked in mid-May and are someway off their highs. What about the dollar, that’s been strengthening, another hawkish signal. Joining the falling oil price is practically the whole of the rest of the commodity complex with both softs and metals in downtrends. Even Gold is now 30% off its peak in January and Bitcoin has been in crash mode for some time now.

The equity market has begun to respond to this new paradigm of falling inflation and areas of the market that benefit explicitly from this factor have started to stir from a long-standing slumber. The housing related equities have started to move and there’s been life out of the bond proxy sectors like Staples, REITS and Utilities.

The set up is for a dovish surprise. The prevailing narrative says two rate hikes, the market however says cuts are much more likely. And what of Warsh himself? He may have leaned hawkish last month but as we get the next CPI reading before the next Fed meeting, he will have plenty of room to pivot dovish and present the President with a falling inflation story paired with a rate cutting environment which will be welcomed as the Mid Term Elections come into view in November.