The gods of interest rates are in for their second humiliation

Central bankers are omnipotent, omniscient and omnipresent.

They have a limitless budget to control interest rates, and cannot go bust – so, they’re omnipotent. They are omniscient in the sense that they know absolutely everything about the economy – how else could they claim to control it with a straight face? And they have been buying all sorts of assets other than their usual government bonds over the past ten years, making them omnipresent in markets too. Every asset class from stocks to bonds to property now hangs off their every word.

Most important of all, they can make it rain cash from heaven…

Now, imagine being omnipotent, omniscient and omnipresent, but having the bond market call you out nevertheless…

You see, central banks are dumb enough to predict what they’re going to do. That might seem like a safe bet, given they’re the ones who decide what they’re going to do. But, sometimes, they still get it wrong!

They expect to keep interest rates low for long, for example, but then inflation comes along and forces them to hike rates much sooner than they had promised.

Or they expect to hike rates to bring down inflation, but something happens to bring down inflation rapidly, and the anticipated rate cuts come off the table. That’s what’s happening now… according to markets. In fact, markets are predicting rate cuts this year for some central banks!

While central bankers are busy telling everyone what they’re going to do, as any good God does, markets make their own predictions about where interest rates will actually go and when.

When those predictions diverge from central banks claims, it implies there’s something that central bankers are not yet seeing. The market is claiming that central bankers don’t know what they’re doing. And they’re about to make a mistake.

Who should you trust on where interest rates will go? Well, the market predictions are based on market prices, meaning people have money on the line. Central bankers don’t have the same interests, of course. Except for their declared and undeclared investments… but let’s not open that can of worms.

The point is that the central banks and the markets can’t both be right. Either inflation persists, forcing central banks to continue to raise rates, as they’re expecting, or the market is right and something wicked this way comes.

Markets aren’t just expecting central banks to stop hiking interest rates. They’re expecting those rates to come tumbling back down, starting as early as 2023.

Here’s Bloomberg:

Federal Reserve officials are making a full-court-press effort to convince investors they won’t be slashing their benchmark interest rate before year’s end.

It’s not working.

Money markets are pricing a rate peak around 4.9%, followed by nearly half a percentage point of rate cuts by the end of 2023. That’s despite multiple officials in recent days delivering a sharply contrasting message: Rates are heading above 5% and will stay there all year.

The people just aren’t listening to their gods. And who can blame them after the last few years of completely incorrect predictions of what the gods would do?

But what has markets so worried? What could force central banks to cut interest rates as early as this year?

That’s a bit like asking which snowflake could cause the avalanche. It sort of misses the point.

Central bankers have created a vast pack of snow with their quantitative easing (QE) and promises to keep interest rates low. We’re talking property buyers who can’t afford their mortgages at higher rates, companies that can’t afford to roll over their debt, governments that can’t afford to pay interest at these levels and plenty more.

Having dumped all this snow to make the economy look good, central bankers are now running around the valley yodelling about bringing down inflation.

The market is saying they’ll trigger some sort of crisis with their higher interest rates, just as they triggered inflation with their loose monetary policy. The point being that, on both counts, things will get far worse than central bankers anticipated. The inflation got out of control, and the crisis that forces interest rate cuts this year will too.

The good news for investors is this: if inflation is slayed by whatever crisis is coming, then central bankers will be off the hook again. They’ll be able to pursue wild monetary policy to keep everything afloat. You only need to make it through the initial scare of the next year before central bankers have your back again.

Just don’t forget who is causing the crisis: the same central bankers who will be claiming they’re fighting the fires once the crisis takes hold.

Nick Hubble
Editor, Fortune & Freedom