Here is a useful chart from Apollo showing the rates applied in the US and Eurozone overnight.
The dotted lines show market-derived expectations, while the solid lines show some valuable historical context.
We know that US interest rates will be cut in September and will continue to fall from there. The pace of the cuts is uncertain but what the market really cares about is the destination.
Apollo claims that the floor for interest rates is now higher, perhaps even higher than the 3% that was priced in. This is a popular belief and is based on the idea that we are in some kind of new era of high inflation due to globalization or other structural factors.
I disagree. I believe that the same structural factors that have kept interest rates between 0% and 1% for the past three cycles are still in place. True, frictions in global trade may increase, but that is not a major change, especially in an increasingly technology-driven world. Moreover, the AI and robotics revolution is likely to lead to a significant improvement in productivity, which will lead to deflation. At the same time, this will lead to layoffs (or a reduction in employment), which will limit any gains in wages.
Again, there are fairly compelling arguments for higher inflation, such as climate change and debt monetization, but in the end, I think deflation wins. While I think the Fed will be reluctant to cut rates below 2.50% in a recession, as job losses mount, it will undoubtedly cut rates.
Of course, the timing of that is highly uncertain, and Powell could execute a perfect cut this cycle that keeps rates near 3%, but at some point a recession will come and rates will return to 1%.
In the short term, I think this is an important consideration for term trading because there is still a chance to hold a (roughly) 4%-6% safe rate. The idea of higher US interest rates and the dollar being exempt is also a big part of the support for the crowded dollar trade. As this illusion fades, we expect pressure on the dollar.
One potential obstacle in this context is the Fed Chairman. Powell and most Fed members agree on this view, but if a more hawkish Fed Chairman (Waller?) is appointed, this could change the equation, although we would also have to consider the negative growth prospects that could come with unnecessarily high interest rates.