Stock and Bond markets as predictors

The WSJ ran an article this morning re: the strong rallies we're seeing in stocks and bonds, and the competing views of the future these rallies imply. Either growth will remain strong and inflation under control and stocks have it right, or growth will disappoint to the point where rate cuts will be needed to stimulate the economy and inflation will be a peripheral concern. I have posted on this topic previously, and I still tend to side with the bond bulls.

A couple things - first, the Fed's stated focus on inflation is at this time a bit overblown and behind the times given the data, and I think the only reason they have not altered their statement to reflect any downside growth risk is that BB must still live up to the Fed's history as a staunch inflation fighter. His not wanting to include downside growth risks along with inflation risks has single-handedly brought the markets to near all-time highs, and by the time growth slows to the point of revising the Fed statement, it will come as a HUGE surprise to the stock market. Expect this to happen early next year.

Second, here is a chart showing that if history is any guide the FF rate will be in for some hefty adjustments next year. The only other time since 1990 the yield curve was inverted (measured here by 10-yr/2-yr spread) AND the 2-yr yield was below the target FF rate was in 2000...

Obviously the past is not necessarily indicative of the future, but I think the Fed has to ease at some point next year. The likelihood that they hit it dead-on with 5.25% is next to none, and another rate increase would absolutely rattle the markets at this point - it's a little shaky as it is. I think the Fed is pigeonholed into keeping rates steady for the remainder of this year to preserve its inflation-fighting cred, but as soon as BB thinks he can get away with it, the Fed will cut.